Tag Archives: Consumer Discretionary

article 3 months old

Weekly Broker Wrap: Automotive, Utilities, Prostheses List, Grocery And BWX in China

-Import changes slightly negative for APE, AHG
-Wholesale electricity tailwind for utilities
-Woolworths sales remain under pressure
-BWX's substantial growth opportunity
 

By Eva Brocklehurst

Automotive

From 2018, consumers will be able to directly import new cars or motorcycles. They will need to meet Australian safety standards, be right-hand drive and less than 12 months old with less than 500,000km on the clock.

The special import duty on used vehicles will also be removed. At present only Japanese and UK cars meet the standard for import but legislation is planned to change this although there is some early opposition to the changes.

Credit Suisse does not expect a material impact on new or used vehicle prices but believes the change will be a negative for AP Eagers ((APE)) and Automotive Holdings ((AHG)), albeit modest as the dealers are predominantly exposed to the mass market.

Fleet providers such as SG Fleet ((SGF)) and Eclipx ((ECX)) are likely to be unaffected. Leasing providers such as McMillan Shakespeare ((MMS)) and Smartgroup ((SIQ)) are also likely to witness few changes, the broker believes, as novated leasing demand is more influenced by new car sales and finance trends while fringe benefits tax is a more significant issue.

Utilities

The improving outlook for wholesale electricity prices represents a key tailwind for utilities in 2016, Deutsche Bank maintains. Regulated utilities such as Spark Infrastructure ((SKI)), DUET ((DUE)) and AusNet Services ((AST)) face significant final determinations in their Victorian electricity distribution networks.

The broker believes the sector will outperform on earnings growth, sustained low bond rates and improving wholesale electricity prices. APA ((APA)), AGL Energy ((AGL)) and Spark Infra are considered best leveraged to this theme and remain the broker's preferred exposures.

Prostheses List

The federal minister has promised to prioritise prostheses pricing reform and Deutsche Bank regards this a s a medium-term positive, as it should reduce affordability pressures that are driving increased churn for insurers and policy downgrades.

In the near term the earnings impact could be negative for the insurers if the government ensures savings are passed onto consumers through lower premium rises.

Public hospitals are able to shop around for prostheses but the private health insurance industry is required to pay a fixed price to private hospitals based on the prostheses list, and these prices are considered well above domestic and international benchmarks.

Goldman Sachs expects any near-term financial impact on funds such as Medibank Private ((MPL)) and nib Holdings ((NHF)) will be small, if impacting at all. There will be a negative impact on medical device company gross profits in Australia and, in turn, they may seek to reduce any volume rebates they currently pay to hospitals.

Goldman downgrades earnings forecasts by 3.0% for Healthscope ((HSO)) and by 2.0% for Ramsay Health Care ((RHC)). UBS notes both these private hospital operators have previously insisted they would be relatively unaffected by cuts to the prostheses list but at this point makes precautionary reductions to estimates.

Grocery

Competition among grocery stores in Australia has reached new heights, Goldman Sachs maintains, as Woolworths ((WOW)) attempts to resurrect its sales with investment in price, service and inventory.

The broker notes Coles ((WES)) and Metcash ((MTS)) have responded with their own initiatives, keeping any resurgence at Woolworths at bay. Aldi's market share growth, meanwhile, appears to be coming at the expense of Woolworths and Metcash.

The broker compares the Woolworths sales decline with Tesco in the UK, where competition led to a fall in margins, earnings and a sharp decline in the share price. There are some mitigating factors for Woolworths compared with Tesco, the broker acknowledges, given its greater market share and Australia's low population density.

Goldman also revises earnings estimates down for both Woolworths and Wesfarmers in the light of softening food statistics. Margins are forecast to decline at Woolworths and remain flat for Coles.

BWX

Natural skin care product manufacturer BWX ((BWX)) delivered a substantial increaese in interim earnings, up 62%, which for brokers underscores the company's strong potential.

Bell Potter observes the flagship Sukin brand continues to deliver exceptional domestic sale growth and is now poised for a material opportunity in the Chinese market. The broker retains a Buy rating and $3.90 target.

Moelis notes the gross profit margin expanded by 410 basis points as the company transitions from low margin, low volume third party manufacturing. BWX is now net cash. The broker retains a Buy rating and $4.65 target.

Exports commenced in FY16 and this is expected to be the main driver of offshore revenue. The company owns the formulations for all five of its brands Moelis believes the stock is another way to play the growing consumer demand for high quality Australian goods in China.
 

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JB Hi-Fi The Victor

-Sales flow likely from Dick Smith
-Software diminishes in importance
-Some concerns over Home format
 

By Eva Brocklehurst

Retailer JB Hi-Fi ((JBH)) has momentum and a firm platform for growth, with a key supportive factor, most brokers agree, being the decline of electronics competitor, Dick Smith ((DSH)), under administration. At the very least Dick Smith is likely to close stores and there is a high probability it will fold altogether.

JB Hi-Fi was reluctant to emphasise any benefit that may accrue as the result of Dick Smith folding but CLSA, not one of the eight brokers monitored daily on the FNArena database, estimates that up to $300m of Dick Smith's $1bn in sales could flow to its rival. The reality is that the benefits of industry consolidation and the removal of a large price discounter should drive strong top line growth and margin expansion for JB Hi-Fi.

Hence the broker believes the company's $143-147m profit guidance is conservative, forecasting 10% or more in earnings growth over the next three years. CLSA has a Buy rating and raises its target to $28 from $25.

UBS welcomes the top line momentum, driven by telco, fitness, accessories, computers and appliances, as it shows JB Hi-Fi is successfully weaning itself off software sales. Nine more stores were converted to the Home format in the half, taking the total to 56 out of a target of 75. UBS upgrades estimates by 1-6% over FY16-18 and believes the risks are to the upside from industry consolidation and a more rational competitive background.

The narrowing margin in the half-year results, due to higher costs, niggled Citi but the prospect that Dick Smith will close 100 stores and JB Hi-Fi will be the main beneficiary is a supportive factor going forward. Deutsche Bank also cited the higher costs but is comfortable in the fact that management took advantage of robust demand to invest in sales & marketing and will be able to control costs when sales slow.

The stock has outperformed some 30% since December and Deutsche Bank believes the upside is fully priced, particularly as the business has already made market share gains and deals on excess stock from suppliers. This now forms a base. Hence, Deutsche Bank retains a Hold rating.

Ord Minnett is not worried about the margin outlook, despite the increased costs, noting the company has a good track record in cost control and there is scope for medium-term expansion as the Home investment phase comes to an end.

The broker is more confident that sales growth can be sustained and the company is able to cycle demanding comparable periods, upgrading to Accumulate from Hold. Ord Minnett also suspects that the entry of Dick Smith into voluntary administration and an expected reduction of stores, if not complete closure, presents a pool of incremental sales for JB Hi-Fi.

One aspect that concerns Morgan Stanley is the reduction in the gap between like-for-like and total sales growth. The broker's analysis shows that the Home division space is less than half as productive as the existing consumer electronics space, which drives sales per square metre lower. It suggests, allowing for online sales growth, that this key metric for retailers may have been negative in JB Hi-Fi's case during the first half.

Given costs are usually linked to the growth in a selling area, preserving margins while sales per square metre are flat or declining, becomes increasingly difficult, in the broker's view. Morgan Stanley observes similar trends occurred in Woolworths ((WOW)) two years ago.

The balance sheet is improving and that warrants the prospect of capital management, in Credit Suisse's view. Net debt is forecast to fall to $39m by FY17. The broker has not included capital management in its forecasts but estimates a $100m buy-back at $25/share could add 2.0% to earnings per share in FY17.

Credit Suisse did not particularly like the lack of clarity on the performance of the Home format and remains puzzled by some of the locations. The broker believes there is greater risk of Home underperforming than the core format and does not include any material profit in its forecasts from that segment.

The New Zealand business is also considered a long way short of being sustainable but remains a small operation. The company is continuing to build scale in that market and, in this region, the closure of Dick Smith would benefit JB Hi-Fi, the broker contends.

Macquarie observes the company executed well on its promotional strategies and ensured a good depth of inventory ahead of the festive season. The broker suspects the balance sheet position is likely to come into increasing focus with the demise of Dick Smith.

This is because retailer cash flows and debt balances are likely to be under the microscope from investors, suppliers and creditors.  Macquarie expects JB Hi-Fi to be net cash by FY18, which should provide both internal and external investment opportunities.

FNArena's database shows four Buy and four Hold ratings. The consensus target is $23.12, suggesting 3.2% upside to the last share price. This compares with $21.46 ahead of the results. The dividend yield on FY16 estimates is 4.3% and FY17 is 4.7%.
 

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Brokers Buzzing Around Capilano

-Higher prices, increased demand
-Asian exports up strongly
-Vertical integration strategy
 

By Eva Brocklehurst

Brokers are buzzing around Capilano Honey ((CZZ)). The company's first half result beat broker forecasts substantially, with profit up 53%. This may have mostly reflected a stock re-valuation because of higher honey prices and increased demand. Nonetheless, the outcome is considered unquestionably strong. Honey is increasingly popular in health remedies, a benefit the company enjoys both domestically and overseas.

The benefits from selling higher margin honeys such as manuka as well as the integration of Chandler Honey (honey supply) and KirksBees Honey (manuka beekeepers) is underpinning the outlook, brokers maintain. Opportunities abound, brokers believe, in the export potential to Asia, with Capilano selling more of its product through Asian websites direct to consumers.

Capilano's Allowrie brand has taken significant market share from private label products in store, given it was not daunted by supply issues this season as well as being supported by the Chandler acquisition and Capilano's ability to import honey. The company has a strategic alliance with Argentina's largest honey producer, HoneyMax, and has rigorous import supply testing in place.

Seasonal variations in honey supply underscore the need to import honey to service both domestic and overseas customers. The company's Allowrie brand usually blends imported with domestic honey. Allowrie is also priced at a lower point than other branded honeys. Honey is a high-value category for retailers, which make more money from Allowrie than private labels. Hence, the rising honey price is a large spur to earnings growth.

The one miss for Morgans in the numbers was weak cash flow, as the company re-built stock, although this suggests a return to more normal seasons after low volumes in recent years. Morgans believes the stock is attractively priced for its growth profile and has an Add rating with a target of $22.80.

Morgans expects FY16 underlying profit to rise 53%, supported by improved seasonal conditions, rising exports and further market share wins, as well as the benefits of higher margin product. Upside could come from further acquisitions, the broker maintains, and from corporatising manuka beekeeping.

Canaccord Genuity also lauds the accretive potential in manuka honey. Even outside of the specialities, the outlook is strong for Capilano, with the honey season likely to be up 15-20% amid buoyant export demand. The broker upgrades to a Buy rating and a target of $21.54, following the recent pull-back in the share price.

Canaccord Genuity expects Capilano will retain its domestic market dominance as well as feed export demand. Moreover, honey consumption lifts in the lead-up to and throughout the northern winter, which should ensure a seasonally stronger second half. Key catalysts for the stock, in the broker's view, are confirmation of a strong honey season and corporate activity, both in terms of acquisitions or Capilano becoming a target.

Canaccord Genuity approves of the vertical integration strategy with manuka honey, which it considers could be highly accretive and deliver further growth in FY17 and beyond, although this is not factored into estimates.

The company does not provide formal guidance but did note its acquisition of KirksBees was progressing well. Capilano cited strong interest in its natural wholesome products, also expecting a new product range will ensure it prospers.

Revenue of $67.1m was up 16% on the prior corresponding half and market share increased to above 76% from 74%. Exports remain a large driver of the results, up 35%, with exports to Asia up 53%. As per usual practice the board did not declare an interim dividend.

Capex rose to $1.96m from $1.74m, stemming from the re-commissioning of the Maryborough factory in Victoria, which has increased the company’s capacity and supply of glass jars and non-honey products. The company also invested in KirksBees to bring it in line with corporatised farming practices. The company spent $6m acquiring KirksBees.
 

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BWX Offers Alternative Growth Play On China Demand

-Strong growth rates for key brand
-Offshore revenue growing substantially
-$A weakness a challenge
 

By Eva Brocklehurst

Personal care products manufacturer, BWX Ltd ((BWX)), is expanding its natural skin care cosmetics to China. Exports commenced in FY16 and this region is expected to be the main driver of offshore revenue.

The company owns the formulations for all five of its brands, with Sukin the flagship brand, and aims to provide high quality natural skin and hair care at an affordable price.

Moelis believes the stock is another way to play the growing consumer demand for high quality Australian goods in China. The broker initiates coverage with a Buy rating and 12-month target of $4.65, estimating a 28.2% total return comprising a 1.2% dividend yield and a 27% capital return.

The broker believes the strong operating momentum and exposure to China's middle class could drive an upgrade to consensus estimates, which have the stock trading on a FY16 enterprise value/earnings ratio of 18.2, a premium to skin care peers.

In the broker's opinion the stock should command a multiple similar to other stocks which are experiencing high demand in China, such as Blackmores ((BKL)) and Bellamy's ((BAL)). Moelis forecasts a distribution of 4.3c per share in FY16 and 9.5c in FY17. Gross profit margin of 59.9% is forecast in FY16.

The investment thesis is based on the anticipated 65% growth in Sukin's offshore revenue in FY16. The skin care market is expected to growth at a 9.0% per annum rate in China over the next five years.

Moelis assumes BWX will use foreign e-commerce sites for shipment into China. China's contentious animal testing requirements were removed in June 2014, but only for domestically produced cosmetics. Products sold in China such as skin care, deodorant and hair care still require animal testing if they are manufactured outside China. Cosmetics purchased from foreign e-commerce sites for shipment to China avoid this animal testing requirement.

Moelis ascertains that Australians are increasingly willing to refrain from buying products that are unsustainable, unethical and/or include harmful ingredients. The biggest barrier to purchasing natural products is considered to be the price and the broker believes Sukin's price point, at the premium end of the mass market, is a major contributor to its growing popularity.

The company is generating cash, which should support future acquisitions and new products. The Australian market is fragmented, with a number of brands needing research, production, warehouse and logistics capabilities as well as working capital. Moelis estimates BWX could comfortably take on $35m in debt for acquisitions.

The market for beauty products is highly competitive and there are large multinationals that have greater resources to respond to changing conditions. Moelis acknowledges this as a risk, as well as any move by the Chinese government to protect the local industry, which could be detrimental to BWX.

Another risk is that the continued depreciation of the Australian dollar will make inputs sourced offshore relatively more expensive. The broker believes it would be challenging for the company to raise its prices in this scenario, as it aims to maintain a “masstige” price point and increase market share through volumes.

Sukin was launched in 2007 and acquired by BWX last year. Moelis estimates that 90% of the product is sold in pharmacy stores. Sukin products, according to the company's prospectus, grew 40% over the year to August 2015, higher than the 29% growth rate attributed to natural skin care products in Australian pharmacies. Moelis forecasts 38.8% growth in domestic sales for Sukin in FY16.

BWX also owns four other brands, which fill the company's desire to have a portfolio across a number of sales channels and demographics. Derma Sukin is formulated for those with sensitive skin, The Uspa range consists of products for use in professional salons and the day spa market.

Renew Skincare is a brand of organic products which use rose hip oil and is sold in the Australian market via a network of distributors. Edward Beale hair care products a sold through speciality retail outlets.

The company also manufactures for third parties, which constitutes 21.8% of the broker's FY16 revenue expectations. BWX is reducing its third party manufacturing revenue in FY16 by 15% as it migrates some customers.

While intent on marketing its own brands, the company will continue to provide services to Brut, Skin Doctors, MOR and Mr Smith. This third party demand is driven by customers inability to self-fund their own faculties and the need for integrity, traceability and safety of ingredients.

The largest export markets for Sukin in FY15 were New Zealand, the US, Canada, Singapore and the UK. The company’s manufacturing capability is located in Victoria.

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Expanded RCG Footprint Provides Strong Outlook

-Buying opportunity arising in the stock?
-Accent sales growth may slow from high rate
-Accent synergy estimates very conservative
 

By Eva Brocklehurst

Footwear distributor and retailer, RCG Corp ((RCG)) is intent on unlocking the strategic benefits that will arise from its acquisition of the Accent group, with cross selling of brands and supply chain opportunities aplenty. Indeed, the current pull back in the stock presents a buying opportunity to Moelis, with RCG having reached a high of $1.80 in December before easing back at the start of 2016.

After a strong Christmas trading period the broker notes exceptional demand for apparel and footwear, which was underpinned by a falling Australian dollar that brought customers back to shopping precincts and away from online purchases.

This confirms Moelis' suspicions when initiating coverage on the stock last November: that consumers will increasingly return to the shops to try on items to obtain the level of service that exists above online offerings. Savings online now appear less important than consumers' desire to receive the goods immediately and, particularly in the case of shoes, have these fit properly, while also enjoying the shopping mall experience.

The Australian Retailers Association has reported an uplift in foot traffic and spending across the country over the holiday season, with higher-than-usual demand for soft goods post Christmas. The broker cites David Jones reports of like-for-like sales growth of 9.7% in the first half.

Moelis believes other factors, such as low interest rates and falling fuel prices, have also provided a positive boost to sentiment. RCG is likely to obtain a further boost from the “back to school” trade at the start of February, although the broker notes gross margins may be affected because of discounting.

Upside risks to forecasts at the first half result are considered highly likely, given the company's earnings sensitivity to higher sales growth, larger store footprints and margins. Assuming the Accent division’s margins are at 14.7%, for every 10% increase in like-for-like sales Moelis estimates this will increase FY16 group earnings by 3.4%.

While RCG has guided to 1-2% earnings margin compression in FY16 in the Accent division, the broker also understands that RCG is opening larger stores. As sales growth increases the broker expects margin compression will reduce and, with like-for-like sales growth above 20%, earnings margins are likely to expand. The company reported at its AGM the Accent division like-for-like sales rose 30% in the first 16 weeks of FY16.

The stock is a key way to play a growing active wear theme in Australia and Moelis retains a Buy rating and $1.75 target. Morgans, too, has an Add rating with a $1.67 target, suspecting the company's guidance at the AGM could prove quite conservative if the critical Christmas/New Year sales period is negotiated successfully.

Morgans believes it is highly unlikely Accent's like-for-like sale growth will slow dramatically and remains comfortable with the stock from a valuation versus growth perspective. The broker expects Accent sales growth of 20%, which implies sales growth slows to 15.6% over the balance of FY16.

Strong earnings upside is envisaged in FY16 with cost synergies evident in FY17. The broker observes management continues to assume no synergies from bringing the RCG and Accent businesses together and considers this a highly conservative assumption. Streamlining of the two supply chains should unlock meaningful cost efficiencies in time.

The company is nearing completion of a strategic review of The Athlete’s Foot and expects the changes being made will underpin growth in coming years. The first 16 weeks of FY16 revealed sales growth of 5.0% in this division. Momentum is expected to continue over the rest of the financial year. Morgans does note this remains the mature network among the company's outlets.

In contrast, management expects to open 28 Accent division outlets in FY16 and the broker expects these will largely involve the Platypus and Skechers brands. Meanwhile the Accent wholesale business, despite no specific numbers being provided at the AGM, is considered to be growing in the high single digits, primarily driven by the Skechers brand.

See also, RCG Corp Well Set To Run Higher on November 16, 2015

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Is Domino’s Pizza Overpriced?

-Further organic trading growth
-Obtains strong potential in Germany
-Is the high P/E ratio defendable?
 

By Eva Brocklehurst

Domino's Pizza Enterprises ((DMP)) is feasting on another acquisition. The company has formed a 67:33 joint venture with Domino's Pizza Group plc, the UK-listed entity, to acquire a major German pizza chain.

The JV will acquire existing Domino's stores in Germany and Joey's Pizza, the country's largest pizza chain, for EUR79m. Joey's Pizza has 25% of this large and fragmented market.

Management has also upgraded FY16 earnings guidance to growth of 30%, from the 25% signalled at its AGM in November. The joint venture will only make a small positive contribution to FY16 (3 months) so the upgrade to forecasts is largely organic, which suggests to brokers that trading has improved further.

Domino's now operates in five of the top 10 developed pizza markets and management continues to target further acquisitions. Management has increased its long-term European store count target by 1,000 to 2,500, taking the group target to 4,250 by 2025.

To gain access to the German market, Domino's will pay the UK entity up to EUR25m to transfer the rights to operate the brand in Germany. Subsequently, 5-10 Domino's stores will close across Germany as well as the Dusseldorf head office and Berlin commissary, at the UK entity's cost.

Deutsche Bank observes the joint venture agreement provides Domino's with a pathway to full ownership at a future date and considers the acquisition strategically sound. It provides a leading position in a large and fragmented German pizza market with substantial scope to increase the store network.

The company has, once again, deployed capital in a low-risk, highly synergistic way, Morgan Stanley contends. This broker remains comfortable retaining an Overweight rating.

The stock is considered a compelling investment opportunity, offering exposure to a solid base in Australia and long-term expansion potential in Europe and Japan. Morgan Stanley highlights the long-term earnings on offer and looks through the demanding near-term multiples.

UBS has shelved its Sell rating in favour of Neutral on the news, factoring in the upgrade to FY16 earnings forecasts and store targets. The broker considers the latest acquisition reflects a excellent business that is supported by a strong management team, factoring in the company's near-flawless execution.

UBS believes, while the move up in the FY16 price/earnings ratio to 56 looks extreme, in the context of the three-year earnings growth rate of around 28% it is defendable. The broker does expect competition in the category in Australia will heat up, as fast food fights for limited dollar growth in consumer spending.

In Europe, UBS believes Domino's will take share in each respective market over the next two years despite challenging, albeit improving, market conditions. In Japan, the broker expects a modest market share shift in favour of Domino's, assuming it is successful in rolling out stores and increasing the mix of take away business.

While no specific synergies were identified, Macquarie accepts that Germany is well positioned geographically relative to the company's other European outlets. The broker believes Domino's deserves to trade at significant premium to peers, given the strong organic growth outlook and its track record on execution.

The investment is considered attractive over the medium term. The joint venture will take up to two years to convert the Joey's stores to Domino's and 1-3 years to test the market before rolling out further stores. Hence, Macquarie does not expect substantial earnings growth in the first three years.

JP Morgan baulks at the stock's multiple of 46 times one-year forward earnings estimates and sticks with a Neutral rating. Even if the company grew earnings by 30% each year it is still trading on 20 times the broker's FY20 projections.

That said, JP Morgan likes the acquisition, with the key advantage being margin expansion from leveraging technology and other systems across a larger distribution base in Europe.

The broker expects European margins to increase to 20% in FY25 from 11% in FY15 and considers the acquisition price also reasonable, given the earnings and value accretion, although it is higher than the price paid for past acquisitions such as Pizza Sprint and Domino's Japan.

FNArena's database has two Buy and four Hold ratings. The consensus target is $53.72, suggesting 1.2% downside to the last share price and compares with $44.92 ahead of the announcement. Targets range from $50.00 to $63.00.
 

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Will Dick Smith Infect Electronics Retailing?

-Contagion likely to be limited
-Segment margins could be squeezed
-Long-term may benefit JBH, HVN
 

By Eva Brocklehurst

Dick Smith ((DSH)) has a problem, a serious problem. The company has such a substantial inventory overhang, to the tune of $60m, that it will weigh heavily on sales growth over Christmas.

The share price has been trounced and brokers have downgraded targets substantially. Deutsche Bank has reduced its target to 30c from $1.00 and Macquarie to 50c from $1.00.

While the majority of the company's inventory write-down is private label this is not altogether the case and Macquarie suspects further impairment may be required, dependent on how Christmas trading fares.

The company has backed away from prior earnings guidance, without providing any detail, and remains intent on reducing inventory and debt levels ahead of profits. The relative size of the current provision, versus the inventory held at the end of June, is a surprise and Macquarie considers this a poor reflection on underlying value and profitability.

The issue raises doubts about the outlook for the brand and the broker expects the stock to trade at a large discount until its cash position is stabilised, and it can again show stable sales growth and margins.

Credit Suisse notes the balance sheet is starting to look strained. The broker estimates the company has two key covenants. One is gross debt/earnings of 2.5 times which would require, using total debt of $70.5m in FY16, at least $28.2m earnings to avoid a breach.

Assuming the facility was fully drawn to $135m, this would require earnings of $54m. A free cash cover covenant of 1.3 times requires a minimum of $35m in earnings on Credit Suisse's FY16 estimates.

The broker believes there is more downside risk in the short term, amid a host of potential negatives including loss of supplier support, such as access to new product releases or adverse changes to creditor terms, and cannibalisation of higher margin sales with significantly discounted products.

There is also the risk of an aggressive competitor response over Christmas. Several brokers have looked at how the news reflects on competitors JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)).

UBS considers JB Hi-Fi more exposed to the step-up in Dick Smith's promotional activity but suspects the impact will still be limited. While an irrational competitor does produce a sales risk – as was the case in 2011/12 - this issue is of Dick Smith's making and is occurring in a relatively robust retail environment, which reflects on the strength of JB Hi-Fi and Harvey Norman brands, in the broker's opinion.

UBS estimates there is a 66% overlap with JB Hi-Fi sales and 35% with Harvey Norman. JB Hi-FI has a much greater exposure than Harvey Norman via overlap of store locations. Hence, UBS believes, over time, there is a significant opportunity to take share from Dick Smith and upgrades JB Hi-Fi's rating to Buy from Neutral. The broker retains a Buy rating on Harvey Norman.

Citi is of a similar view, upgrading JB Hi-Fi to Neutral from Sell. There may be no new iPhone to boost sales this Christmas but JB Hi-Fi's recent share price fall is sufficiently pricing in any concerns, in the broker's view.

JB Hi-Fi is likely to suffer some collateral damage, Deutsche Bank maintains but, in the long term, the pressure on Dick Smith could be positive, in that it may prompt substantial store closures to the benefit of JB Hi-Fi's market share.

Deutsche Bank suspected for some time that Dick Smith had an inventory problem but the size is a surprise. The broker is also reminded of 2011-12 when the failure of Woolworths' ((WOW)) Sight & Sound and closure of 70 Dick Smith stores, by then-owner Woolworths, drove significant industry margin pressure.

Deutsche Bank reduces forecasts for Dick Smith earnings by 40% for FY16 and 60% for FY17. The broker refrains from downgrading to Sell, retaining a Hold rating, but acknowledges the future of the business is hard to predict. Moreover, while the private label accessories discounting may not have an impact on JB Hi-Fi, these will be difficult items to clear.

What the broker fears most is that Dick Smith will be forced to discount branded hardware too, in an effort to attract shoppers, and this could force JB Hi-Fi to follow suit. Deutsche Bank does not adjust sales estimates for JB Hi-Fi, but does reduce gross margin estimates.

In 2011/12 both JB Hi-Fi and Harvey Norman margins were affected as a result of their competitor's inventory clearance and the closure of stores. Still, Harvey Norman is not expected to be affected this time around as its growth is in homemaker categories and its stores are less reliant on electronics/IT retailing.

FNArena's database has two Hold (Macquarie, Deutsche Bank) and one Sell (Credit Suisse) for Dick Smith. The consensus target is 37c, signalling 7.2% upside to the last share price. The dividend yield on FY16 forecasts is 18.3% with 9.6% for FY17.

JB Hi-Fi has one Buy (UBS) and seven Hold. The consensus target is $19.86, signalling 11% upside to the last share price. The dividend yield on FY16 and FY17 forecasts is 5.2% and 5.5% respectively. Harvey Norman has three Buy and three Sell ratings. The consensus target is $4.34, suggesting 11.5% upside to the last share price. The dividend yield on FY16 and FY17 is 5.8% and 5.7% respectively.
 

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Weekly Broker Wrap: Aged Care, Consumer Electronics, Housing, Tourism And El Nino

-Short-term funding risk in aged care
-Dick Smith woes unlikely to spread
-House building firm despite affordability decline
-Bright outlook for tourism with AUD decline
-Extreme weather supporting electricity demand
 

By Eva Brocklehurst

Aged Care

Operating conditions appear sound in aged care, featuring high occupancy and rising bond inflows supported by a buoyant property market, in Deutsche Bank's observation. Still, funding reforms overshadow the sector. The broker believes the over-run relative to budget estimates makes it a priority for the government to address the issue.

Hence despite other attractive elements in the sector, the broker has downgraded Estia Health ((EHE)) and Regis Healthcare ((REG)) to Hold from Buy and Japara Healthcare ((JHC)) to Sell from Hold. The reflects adjustments to forecasts to allow for the impact of a freeze on aged care funding indexation from early 2016.

UBS also observes the short-term funding risk for residential aged care but suspects the impact on earnings will be contained to 2-3% at the bottom line. The broker believes if the government were to freeze indexation, currently at 1.3%, that would go some way towards addressing the gap. The government's Mid Year Economic and Fiscal Outlook (MYEFO) due next week may present a possible timetable for any changes.

Consumer Electronics

The efforts to clear excess inventory began in earnest late last week at Dick Smith ((DSH)). Deutsche Bank conducted a number of store visits to get some idea of what was being moved and the depth of discounting.

The majority of products were private label accessories, particularly under the MOVE brand. A large amount is aged with the majority of promotions on accessories to suit superseded hardware. The broker has also observed the depth of discounting is more aggressive in New Zealand.

UBS observes a difficult few months in store for Dick Smith but suspects the risks for the sector are overplayed. An irrational competitor with a 6.0% share does create a risk, nevertheless, and UBS suspects a 30 basis point impact to gross margins for JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)), which would translate to a 3.0% and 1.0% negative impact on first half earnings respectively.

The issue highlights the strength of the JB Hi-Fi and Harvey Norman brands which suggests to UBS a significant opportunity exists over time to take market share from Dick Smith. The broker retains a Buy rating on Harvey Norman and upgrades JB Hi-Fi to Buy from Neutral.

Housing

Deutsche Bank expects growth in FY16 housing starts of around 6.0%, with NSW and Victoria being the drivers partly offset by weaker conditions in Western Australia. Investor finance now represents 73% of total loan values in Australia versus the historical average of 47%, the broker observes.

In contrast first home buyers represent 12%, down from the peak of 29% in October 2009 and from the historical average of 19%. The broker notes some investors may be first home buyers but this is difficult to quantify with certainty.

Nevertheless, home affordability remains below historical averages for all states except Western Australia and Queensland, although the broker does not believe this is at trough levels in any capital city. Housing is expected to remain robust over 2016, with no change to the official cash rate until December next year.

Beneficiaries of this robust environment, in the broker's view, include CSR ((CSR)), although aluminium is a detractor for the stock, Fletcher Building ((FBU)), given its exposure to robust markets in both New Zealand and Australia and Boral ((BLD)), in a strong position given 30% of its sales relate to Australia housing. Deutsche Bank retains Buy ratings on all three stocks.

Tourism

The Australian dollar depreciation has marked an end to cheap overseas holidays, UBS notes, with international travel prices at a record high. While the level of departures is still 25% above arrivals, net arrivals are the best since 2000, which provides some support to consumption, UBS observes. The broker expects, in a subdued economy tourism, at 6.0% of GDP, is likely to become a bright area in 2016.

UBS also expects the Australian dollar to fall to US68c in 2016 as the US Federal Reserve hikes rates and commodity prices remain soft. A lower Australian dollar is expected to underpin strong growth in tourist arrivals, supported by scheduled increase in international airline capacity of 8-10%.

El Nino

Morgan Stanley's El Nino update suggests, thus far, there is an impact on average electricity pool prices. Year-to-date average pool prices are higher in both NSW and Victoria. AGL Energy ((AGL)) is the most leveraged to pool prices, the broker notes.

That company has argued a structural rather than a cyclical view on prices, based on re-pricing of coal and gas supply contracts. Morgan Stanley, however, suspects a cyclical impact. Low rainfall has curtailed Tasmanian hydro production and hotter southern weather means lower demand-coincident wind production in South Australia.

Extreme weather tends to support electricity demand although, longer term, the analysts envisage declining demand and a dampening of prices amid new entrant renewables.
 

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article 3 months old

Collins Foods Delivers KFC Feast

-Tourist areas strongest
-Healthy balance sheet
-Cash flow conversion low
 

By Eva Brocklehurst

Collins Foods ((CKF)) maintains its reputation as a strong KFC franchisee, with a positive contribution emanating from both existing and new and remodelled stores in the first half. Core KFC businesses, largely in Queensland, delivered the strongest contribution, supported by inbound tourism to coastal regions in that state.

Canaccord Genuity observed a number of product launches in the half year as well as brand marketing achieved growth in foot traffic over product prices. This is a signal to the broker the fast food chain is robust and can obtain price rises in the future.

Like-for-like sales growth was 5.2% for KFC, with 170 basis points of margin expansion as a result of operating leverage and cost reductions in the recently acquired Western Australian/Northern Territory business. Revenue was up 5.0% and the first half dividend increased 20% to 6c.

Earnings of $35.3m exceeded Canaccord Genuity's forecasts and the broker increases estimates for FY16 and FY17 by 9%. The broker has a Buy rating and believes the stock is trading at fair value, elevating its target to $5.44 from $5.22.

With an acquisition mandate and comfortable balance sheet, brokers are confident Collins Foods should be able to accrue further accretive KFC restaurants in the future, having stated it was keen to extend the KFC footprint nationally.

UBS also suspects Collins Foods may pursue a master franchise licence for KFC Australia, although this is unlikely in the near term. Cash generation improved but remains relatively low, with the broker calculating a gap of 33 percentage points between operating cash flow conversion and free cash flow conversion. UBS believes this gap needs to be monitored but expects it will close from FY18 onwards as major refurbishments are completed.

Still, the return on invested capital in KFC is now above the weighted average cost of capital for the first time since listing in 2011 and the broker expects new store openings should contribute meaningfully from the second half.

The Sizzler chain closed three stores and no growth capital was allocated to the business in the half year. This business is expected to remain profitable in FY16 but brokers ascribe it little or no value. Sizzler is non-core and brokers expect the chain will disappear in a few years. There are around 2.5 years in average lease life remaining on the Australian network of 23 restaurants.

To UBS, the company has fulfilled expectations inherent in its share price thus despite the strong near-term outlook, the broker downgrades its rating to Neutral from Buy. Sales and margin forecasts are upgraded with the long-run earnings margin for KFC increased to 17% from 15.5%. The target is raised to $4.65 from $3.50.

In contrast, Deutsche Bank believes there is more upside yet and the valuation is undemanding, sticking with a Buy rating and upgrading its target to $4.85 from $3.10. The broker increases FY16 forecasts by 22% and FY17 by 23%, largely from earnings upgrades and lower depreciation and net interest assumptions.

While the company did not provide FY16 earnings guidance, growth is still expected and management has indicated that trading over the first six weeks of the second half has been running at the same rate as in the first half, albeit with a little softness in areas dependent on the mining industry – western Queensland and Western Australia - as opposed to tourism.

Poultry costs, the largest input cost for KFC, are covered until January 2017. The company remains committed to a further 4-5 new KFC openings in the second half and seven remodels. Collins Foods also envisages scope for a further 7-8 new KFC outlets per annum over the next 3-4 years.

See also, Healthy Cash Feed Flows From Collins Foods on November 24 2015.
 

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article 3 months old

Going Remains Tough For Billabong

-Heightened discounting continues
-Weak first half likely
-Potential for long-term recovery
 

By Eva Brocklehurst

Billabong International ((BBG)) requires investors to be patient. The company is progressing with its turnaround strategy, but in the current environment the going is slow.

Citi is disappointed in the update provided at the AGM but concedes trading in North America is difficult. The broker envisages potential for margin expansion,in time, but for the present opts to retain a Neutral rating.

Meanwhile, JP Morgan observes discounting and promotional activity continue to hamper progress, particularly in sports retailing. Billabong has signalled an intention not to participate in such discounting despite the negative impact on revenue among large customers.

Earnings are tracking slightly below expectations and JP Morgan increases its forecast decline for the first half, while recognising December is a key trading month, particularly in Australia. The pace of margin expansion has also moderated.

The broker is upbeat about the longer-term potential, although the path ahead is uneven. FX is becoming a challenge and, despite valuation support and confidence the company will make it through, JP Morgan retains a Neutral rating until signs of greater stability are forthcoming.

Deutsche Bank is sceptical about the claim that the weaker Australian dollar has impacted earnings, given margin pressure in Australia should be more than offset by favourable translation from larger US businesses.

What is clear, nonetheless, is that trading conditions in the US are weak and competition is intense. The second half of FY15 was pleasing but, since then, the broker notes momentum has stalled. The brands may be strong and the company gaining market share but, Deutsche Bank asserts, turning this into profits is the difficult part.

No guidance was provided, but the skew in earnings towards the first half is likely to be less than usual. Hence, the broker suspects first half results will be weak but the second half will improve as cost savings initiatives deliver benefits.

Deutsche Bank reduces earnings forecasts by 15-17% across its forecast period. The broker also flags the large interest expense is becoming more onerous as the Australian dollar weakens.

At current levels Deutsche Bank considers the stock fairly valued, given potential earnings upside is offset by execution risk, delays and an expensive capital structure. FNArena's database contains three Hold ratings. The consensus target is 59c, signalling 14.6% upside to the last share price.
 

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