Tag Archives: Consumer Discretionary

article 3 months old

Wesfarmers Upholds Resilient Outlook

-Bunnings resilient to housing downturn
-Coles likely winning share
-But food deflation accelerates
 

By Eva Brocklehurst

Conglomerate Wesfarmers ((WES)) sustained a strong September quarter for its retail businesses. Brokers note even Target, which has struggled for some time, appears to have turned around.

Overall, sales grew by 6.5% ex petrol, and this should allow Wesfarmers to invest in prices and maintain healthy margins, Deutsche Bank maintains. Home improvement (Bunnings) impressed the broker as that division's sales rose 8.2%, cycling similar growth in the prior corresponding quarter.

Percentages may ease in future, the broker suspects, given the level of market penetration. Trade accounts appear to be making up a larger proportion of sales at Bunnings now and this suggests to Deutsche Bank the business could become more volatile.

What about the slowing housing construction outlook? Brokers are not that perturbed, given the market share Bunnings holds. Credit Suisse suspects the future of competitor Masters, owned by Woolworths ((WOW)) is the main variable for Bunnings.

The broker suspects closure of the Masters chain would be a benefit to Bunnings, while a change in ownership and strategy on the back of an exit by Woolworths could produce the reverse. Macquarie dismisses the slowing housing outlook, citing the resilience of Bunnings and lack of competition if Masters is wound up.

A new spurt of growth was evident at Kmart, as the chain expands its range. Citi suspects one third to half of the Kmart sales growth in the quarter emanated from the problems that competitor Big W (owned by Woolworths) endured in its inventory systems.

Target also recorded its first quarterly sales growth in several years, with fewer mark downs in the quarter. Credit Suisse considers this development validates the re-positioning of the Target image. While it is early days, Deutsche Bank also believes Target is showing promising signs.

Meanwhile, food price deflation has increased to 1.3% in the quarter, its highest rate in two years, which highlights the prospect that profit growth is slowing for Coles. In the absence of sales figures from Woolworths, Deutsche Bank highlights the difficulty in determining the extent to which Coles has outperformed.

Still, there are signs Coles gained considerable market share in the quarter. Morgans is confident Coles is winning the battle in the supermarket arena and it should deliver reasonable sales growth, even during a period of structural change and competition in the industry.

Brokers also believe the performance of Coles has been boosted by the weak performance of Woolworths. The higher level of price deflation signals the likelihood that margins will continue to compress across the supermarket industry as players increase their levels of price investment. In this regard, Morgan Stanley forecasts Coles earnings margin to compress to 4.7% in FY20 from 5.4% in FY15.

Goldman Sachs makes the observation that there was no comment from Wesfarmers on the impact that price competition was having on margins. Downside risks that Goldman Sachs contemplates include a resumption of "price wars" in groceries and a successful turnaround for Masters.

Goldmans, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating and $50.50 target for Wesfarmers.

Most brokers expect the slowdown in two key divisions - food and home improvement - will limit upside for the share price. Several consider Wesfarmers a good business with strong management but fair value.

JP Morgan believes the modest valuation support and no imminent change in the portfolio, with a lack of impetus in the industrial divisions, means the share price is likely to remain range-bound.

Citi suspects that some of the sales growth in the quarter is largely a reflection of less stable rivals. The broker questions the price being paid for Wesfarmers' growth and sticks with a Sell rating.

Morgans, on the other hand, believes the premium to Woolworths is entirely justified and the stock offers an attractive mix of reliable earnings growth and yield. Hence the broker retains an Add rating.

FNArena's database has two Buy ratings, six Hold and one Sell with a consensus target of $41.74, suggesting 0.4% downside to the last share price. Targets range from $35.80 (Citi) to $45.08 (Macquarie). The consensus dividend yield on FY16 and FY17 is 5.0% and 5.3% respectively.
 

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article 3 months old

Modest Outlook Maintained For Super Retail

-Concerns over margin recovery
-Customers sensitive to price
-Acquisitions taking longer to pay off
 

By Eva Brocklehurst

Broker views diverge somewhat on the outlook for Super Retail's ((SUL)) businesses in FY16. The company's AGM revealed automobile and sports categories are performing best, while leisure continues to experience softness related to restructuring activities. The margin in leisure was lower largely because of clearance activity at Ray's Outdoors and a continued focus on competitive pricing at BCF.

The divergence in outlook is reflected in FNArena database, which has five Buy ratings, one Hold and two Sell for Super Retail. The consensus target is $10.07, suggesting 8.3% upside to the last share price. The dividend yield on FY16 and FY17 estimates is 4.7% and 5.2% respectively.

JP Morgan is concerned about the potential to recover margins in recently acquired businesses. Gross margins have increased in the first half so far for automobile and sports categories and declined in leisure. The broker also cites a risk of a slowdown among consumers in Queensland, where the company is strongly represented, as well as a lack of valuation support.

The company may have a leadership position in fragmented retail categories and significant opportunities to increase market share but there are several issues which underpin JP Morgan's Underweight rating.

Recently acquired businesses, such as WorkoutWorld and Infinite Retail, are struggling as integration continues, and there is a risk that further acquisitions will be undertaken to meet the company's ambition to be one of the five largest retailers in Australasia.

JP Morgan would become more constructive on the stock at a lower share price, or once improvements in the new businesses become more certain.

Store opening targets are largely as expected, although Deutsche Bank notes closures in sports stores are ahead of expectations, with seven to be closed versus prior indications there would be just three.

The broker also observes, while the automobile sector is resilient, customers remain highly sensitive to price and this will be a challenge over the next year, as currency hedges are rolled off.

Although earnings are likely to improve over the next year, Deutsche Bank highlights the amount of capital that is being used to underpin this expansion. The re-positioning of Ray's Outdoors is not expected to be easy and there is downside risk emanating from currency headwinds.

Automobile and sports sales have accelerated on the back of reduced discounting and UBS is more upbeat, expecting the company will achieve a 14% rise in earnings in FY16. Beyond, the broker considers there is upside risk should the company execute on its efficiency target. The broker forecasts 11% 3-year compound growth in earnings over FY16-19.

Drivers of this forecast include ongoing strength in sports and improved margins via the managing of mark downs and the sales mix, as well as working capital release from a reduction in costs over the next 2-3 years. UBS considers the stock offers a compelling investment proposition on a medium-term view.

Morgans also likes the stock for its FY16 multiples with a price/earnings ratio of 14.4 against forecasts for 15% earnings growth. The broker understands that the clearance activity at Ray's Outdoors is being reduced. Also,WorkoutWorld and Infinite Retail are on track to be integrated into the sports division by Christmas.

Management expects a small trading loss in these two businesses ahead of full integration. Morgans acknowledges management did not reiterate guidance that these two would break even in FY16.

WorkOutWorld is on track, as Morgans understands, while Infinite Retail is taking long than expected and could produce a $2m earnings loss in FY16. Still, the broker suspects there is enough momentum in the rest of the business to offset this impact.
 

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article 3 months old

Vitaco Energised For Healthy Chinese Demand

-Strong industry fundamentals
-Well placed to exploit Chinese demand
-In-house manufacturing a plus
 

By Eva Brocklehurst

The nutritional supplement industry in Australasia is strong... and healthy. Local producers of vitamins and supplements are further supported by Asian consumers, who consider such products manufactured in Australasia are "clean and green". Three brokers recently initiated coverage on vitamin, sports nutrition and supplement manufacturer, Vitaco Holdings ((VIT)) citing the opportunity in China, in particular.

The company manufactures most of its product in Auckland, New Zealand, and exports a range of products to over 30 countries. Its well-known brands include such names as Nutra-Life, Wagner, Healtheries, Musashi, Balance, Aussie Bodies and Abundant Earth. These products are in categories that are primed for substantial growth, Morgans maintains. On a per capita basis Australasia is among the largest consumers of these products globally. Vitaco Holdings listed on ASX last month.

Morgans initiates coverage with an Add rating and $3.25 target, noting the company is benefiting not only from growing sports participation and gym attendances but also from Chinese demand for locally manufactured products.The opening up of China's trade, e-commerce and a falling Australian dollar are also factors in Vitaco's expansion.

Morgans expects double-digit growth for many years to come. FY17 should also include removal of duplicated costs following the Musashi acquisition. This year the catalysts include profit upgrades, expansion and further accretive acquisitions.

Morgans believes the main risks are rising input costs, adverse FX, and competition. The stock is also considered an attractive takeover target, especially to international groups seeking an entry point in Australasia or, alternatively, domestic pharma/nutrition companies wanting a more dominant footprint along with the ability to leverage strong Asian demand. There are barriers to entry for offshore suppliers to the Australasian market, with high levels of regulation and certification required.

Vitamins and supplements make up 44% of Vitaco's revenue with sports nutrition a further 38%. The products are exported through a broad range of channels. By sales revenue, Healtheries is the number one brand in the vitamins category in New Zealand and Aussie Bodies the number one brand in sports nutrition in Australia.

Citi also believes the company is well placed to exploit growing Chinese demand and forecasts FY16 earnings of $22.5m, 12% ahead of prospectus forecasts. The company generated $14m in product demand in Asia (mostly China) in FY15, the broker observes, and this is expect to rise to $52m by FY18. The company is the only listed NZ-based manufacturer and is lifting its marketing intensity towards Chinese consumers.

Citi considers the trading multiples are fair, with a price/earnings ratio of 27 on the back of forecast compound earnings growth rates at around 29% out to FY18. Upside should be driven by better sales growth in China, which has boosted the multiples for relevant comparable companies, the broker observes. Citi has initiated coverage with a Neutral rating and $2.85 target.

Of most interest to the broker is the fact the company does most of its own manufacturing and sports categories have significant sales and margin growth. The Chinese market represents 23% of Citi's valuation. Sales of products for consumption in China, which is 8.0% of total revenue, are handled by Chinese traders which purchase the product in Australia, largely via e-commerce platforms.

The broker also expects the brand profile to improve through marketing expenditure. The company is at a disadvantage to large competitors such as Blackmores ((BKL)) and Swisse in terms of its size but its security of supply is a potential advantage, in the Citi's opinion, because of in-house production and a unique NZ heritage. Still, the lack of marketing scale needs to be addressed in order to build the brand profile, the broker asserts.

Risks include customs and registration in China. There are proposed changes in the wings, but the restrictions still appear to Citi to be tight regarding imports of vitamins. If they become easier, however, there may be more global competition for vitamin sales in China.

JP Morgan takes up coverage with an Overweight rating and $3.00 target, noting that over the last five years the vitamin and supplements category in Australia has grown at a 9.6% compound annual rate with sports nutrition growing at a 14% rate. An ageing population and growing awareness of the importance of preventative health measures are a trend which the broker believes will underpin further growth for Vitaco.

Vitaco's vertically integrated business model is a key feature of the company, the broker contends. It controls a large portion of its manufacturing base and this is a key strategic advantage given the majority of its competitors rely on third-party contract manufacturers. The benefits of this in-house production include lower cost of goods sold, quality control and the speed to market.

A total of two Buy ratings and one Hold feature for Vitaco on FNArena's database. The consensus target is $3.03, signalling 10.3% upside to the last share price.
 

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article 3 months old

Weekly Broker Wrap: Oz Economy, Profits, Drought, Housing, Hardware, Hospitals And Insurers

-Low non-financial profit growth
-Drought in a vulnerable economy
-Westpac move may impact housing
-Operating theatres key to performance
-Online earnings forecasts diverging
-Insurance margin correction factored in
 

By Eva Brocklehurst

Australian Economy

Financial conditions suggest to Citi that Australia's economic growth is weak. The influence of lower official interest rates is waning and the recent moves by Westpac ((WBC)), if followed by other banks, could work to tighten conditions. The broker cites recent sales activity in the property market which supports a view that house price growth has peaked.

The broker forecasts GDP growth at 2.3% by the end of 2015 and averaging 2.4% over 2016. Citi suspects the Reserve Bank will shave 25 basis points off its growth forecasts in its November statement on monetary policy.

Corporate Profits

Non-financial company profit share of GDP has declined by over 3.5% since 2011, Citi maintains. Lower commodity prices are not the only reason for the weakness as, stripping out mining profits, the decline is still noticeable and the profits have underperformed the US. Citi suspects this could, at least partly, reflect lower productivity growth. Consensus has profits recovering strongly, at around 10%, in 2017 whereas Citi is more cautious, expecting around 6.0%.

The broker believes the longer-term outlook is predicated on how successfully the economy re-balances and diversifies its export base. Still, the broker believes the combination of low profit growth and high dividend pay-out ratios is toxic for investment spending and should maintain the prospect of further easing from the Reserve Bank.

Drought

Goldman Sachs wonders whether drought will be the straw that breaks the camel's back for Australia. A rare combination of an intense El Nino event in the eastern seaboard is coinciding with a strong positive phase for the Indian Ocean temperatures which has occurred on only seven other occasions since the 1950's and is consistent with severe deficiencies in rainfall and high temperatures.

Currently, government forecasts assume flat farm production in 2015-16 compared with the median decline of 20% during a drought year. Goldman notes, fortuitously, the severe droughts of 2002-03 and 2006-07 coincided with robust economic growth.

While identification of a drought does not in itself provide a rationale to ease monetary policy it appears to the broker that, in a period where non-farm growth is already below trend and inflation contained, it may be sufficient reason to warrant additional monetary easing.

Housing & Property

Morgan Stanley believes the 20 basis point increase to Westpac's mortgage portfolio will put a dent in housing sentiment. New investors face higher rates and tighter lending standards and this strengthens the broker's belief that the housing boom has peaked. Already, there is evidence of softening auction clearance rates and investor activity, amid weaker house price forecasts.

Morgan Stanley's forecast for a looming oversupply to housing makes the prospect of rental growth and capital gains particularly uncertain. This is all part of what the broker believes is a deliberate macro prudential strategy to rein in the housing market.

Against this backdrop the broker believes there is limited re-rating potential for the residential Australian Real Estate Investment Trusts (A-REITs).  Based on Morgan Stanley's analysis, interest rates are the dominant driver of house prices and house price growth is the key driver of Mirvac Group ((MGR)) and Stockland ((SGP)), in terms of their free funds from operations.

The two stocks have de-rated over the past 6-9 months. Hence, the broker expects further de-rating is questionable, given merger & acquisition pre-conditions are strong, balance sheets can support buy-backs and there are supportive distribution yields.

Hardware

Hardware retailing sales are robust, with the strongest growth in Sydney and Melbourne, Morgan Stanley observes. At a recent industry conference the broker noted the shift to multi-residential developments is creating a headwind for the sector because these developments are large enough to source product offshore and bypass the retail/wholesale channel in Australia.

Participants at the conference also signalled to Morgan Stanley that Bunnings market share is being understated at around 18% and it is more likely closer to 40-50%, given the Wesfarmers' ((WES)) owned business overstates its addressable market.

Morgan Stanley notes the general view that margins at Bunnings have held up despite like-for-like sale growth because of the extent of new store openings, as the business over-services customers in the first six months of opening. As sales increase and customers become aware of where products are within stores, labour is reduced and, hence, margins improve.

Packaging

Morgan Stanley has initiated coverage on the Australian paper and packaging market with a counter-consensus Cautious industry view. The broker expects structural headwinds will cause Amcor ((AMC)) to underperform while progressive reallocation of capital will mean Orora ((ORA)) outperforms.

Amcor has been rewarded in recent years for its defensive characteristics and high returns but delivering the earnings required to support its premium multiple and value-creation target is becoming harder, Morgan Stanley maintains. In contrast, Orora has a largely unencumbered balance sheet and potential to deliver upside through optimisation of its capital allocation strategy.

Australian Online

Pure online classified companies such as Carsales.com ((CAR)), Seek ((SEK)) and REA Group ((REA)) have experienced two years of price/earnings de-rating although Citi notes they are still trading above the historical valuation lows experienced just after the global financial crisis. Meanwhile, Fairfax Media ((FXJ)) and Trade Me ((TME)) have re-rated recently.

The broker finds REA Group the most attractive in value terms, despite a premium multiple, while Carsales.com, Seek and Trade Me are seen trading near peak relative valuations. At the same time most earnings expectations have been deteriorating, with Seek suffering the largest downgrades but Fairfax enjoying incremental upgrades in earnings expectations. Citi now observes a large divergence in earnings growth expectations across the sub sector.

Private Hospitals

The efficiency of operating theatres is a key component in the overall financial performance of a private hospital, Credit Suisse contends. The broker's analysis suggests Ramsay Health Care ((RHC)) generates 35% more earnings per operating theatre than does Healthscope ((HSO)), for several reasons. These include higher case payments, lower operating costs and more efficient processing of patients, as well as more complex surgical patients which generate higher earnings per case.

The broker believes a reduction in operating costs through procurement and workforce de-leveraging is achievable for Healthscope in the short to medium term and this should facilitate a modest uplift in earnings. Other factors citied above are harder to achieve, Credit Suisse acknowledges, and benefits accrue over a longer term.

Insurance

UBS finds more widespread evidence of personal lines claims inflation and modest price increases. Commercial lines appear soft, still. The broker believes, while the picture is mixed, a healthy underlying correction in margins is now reflected in FY16 estimates. Even if margins trough at 20-30% below their peak, with a subsequent 10% hit to earnings, this could increasingly be tolerated by investors.

Challengers have pulled back share in the highly contested motor class, to 12.7% from 13.4% in the broker's previous review. While the challengers continue to generate superior growth at 18% compared with 3.4% for Suncorp ((SUN)) and 0.4% for Insurance Australia Group ((IAG)) there are some signs of consolidation, UBS observes.
 

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article 3 months old

Interest Increases In Billabong

-Margin expansion potential
-Early success in turnaround
-Quiksilver problems an opportunity?
 

By Eva Brocklehurst

Surfwear and accessory manufacturer Billabong International ((BBG)) has triggered interest at Canaccord Genuity, with expectations there is a margin expansion story buried in the company's outlook. The broker believes recent investor presentations have put the stock back on the radar for investors and analysts and this could be a positive catalyst if the company's strategy continues to bear fruit.

Margin expansion provides the short term potential, as management implements a strategy of simplifying its supply chain and prioritising its brand. The expansion will come from improvements in sourcing and changes to logistics, as well as the roll out of the omni-channel distribution platform.

Improvements in sourcing have scope to drive 300 basis points of margin while distribution and logistics could add another 150 basis points, the broker contends. A reduction in the timeline from designer to market is also expected to cut waste and improve the company's response to trends. The brand structure is being rationalised with the intention to have fewer but larger brands. The big three will be Billabong, RVCA and Element.

The company's earnings margins increased to 6.2% in FY15 from 5.9% in FY14 and management has signalled a desire to return this to double digits in the next few years. Canaccord Genuity considers this eminently achievable. The broker also envisages upside risk to revenue forecasts as marketing efforts and merchandising strategies ramp up.  Earnings estimates are based on a step up in margins to 8.6% in FY16.

The management team has limited interaction with investors, usually, outside of the regular half year and full year briefings. Since the FY15 result management has actively engaged with investors in presentations and has signalled it believes internal change will be the driver of earnings growth rather than general industry trends or factors outside of its control.

Canaccord Genuity hails the intense focus on implementing the turnaround and the success with the early stages. The broker envisages some upside risk to revenue growth forecasts for the US and European operations, which should provide additional earnings leverage.

Existing high cost debt facilities could be refinanced in FY18, the broker believes, despite an apparent early repayment charge which appears expensive. The broker understands this charge drops significantly after November this year, to 6.0% from 11.0%, and continues to decline throughout the remainder of the four-year term. Additional benefits which would come from repaying the loan early include the ability to sell assets, pay dividends or undertake other capital restructuring.

Three is another aspect to the broker's confidence. Competitor Quiksilver has recently filed for Chapter 11 bankruptcy protection in the US to allow it to restructure its property portfolio and refinance its balance sheet. While not commenting on this situation, Canaccord Genuity does suspect this could provide Billabong with an opportunity to take market share from one of its largest competitors.

The broker, not one of the eight monitored daily on the FNArena database, initiates coverage of the stock with a Buy rating and 90c target. The target is based on an enterprise value/earnings multiple of 10.7 on FY16 estimates. A two-year valuation based on the same multiple for FY17 is $1.14, representing 69% upside from the current share price.

Brokers on FNArena's database appear much more circumspect. Last month JP Morgan flagged a suspicion that the retail environment in the US had worsened. The broker does not deem the risk/reward compelling enough and pulled back its rating on Billabong to Neutral at the time.

Deutsche Bank also suspected, in the wake of the FY15 results, that the benefits of a turnaround are fully priced in and the outlook remains challenging. There are three Hold ratings on the database with a consensus target of 68c, suggesting 0.2% downside to the last share price. Targets range from 65c (Deutsche Bank) to 70c (Citi and JP Morgan).
 

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article 3 months old

Weekly Broker Wrap: Ad Blockers, Outdoor, R/E, Debt, Global Growth, Bonds And Surfstitch

-Online ads accelerating move to mobile
-Outdoor ad share of media spending rises
-Debt collector returns under pressure
-Extended emerging market weakness
-Means US tightening pace pared back
-Bond yields disconnect from growth
 

By Eva Brocklehurst

Ad Blockers

Ad blocker software, which prevents websites from loading advertising content, is gaining ground. Citi notes the global adoption rate of Ad blockers is growing at around 41% per annum. Primary usage is at the desktop level but the Apple iOS9 update now allows ad blockers on mobile, threatening to reach the mass market.

Citi cites statistics which reveal ad blocker use in Australia is 18% of the internet-using population with the potential lost advertising dollars reaching $1.4bn in 2016. The most at risk media companies are those which have high exposure to desktop display advertising such as Fairfax Media ((FXJ)), News Corp ((NWS)) and Nine Entertainment ((NEC)).

Ad blockers are accelerating the move in online advertising to mobile from desktop, in Citi's observation. The higher penetration of ad blockers is expected to curtail market growth rather than destroy the current value of online display. Publisher strategies to address the risks include native advertising content and renewed attention to subscription models and applications.

Citi estimates a 10 percentage point increase in the penetration of ad blockers would negatively affect Fairfax by 8.0%, News Corp by 6.0%, Nine Entertainment by 5.0% and APN News & Media ((APN)) by 3.0%, in terms of the percentage of profit in FY16.

Outdoor Media

Outdoor advertising revenue grew 23.1% in September, bringing the third quarter growth rate to 13%. UBS observes growth occurred across all vertical markets. The latest data suggests outdoor continues to capture market share from other media. The outdoor share of traditional media spending increased to 7.8% in FY15 from 6.6% in FY14.

UBS suggests the next catalysts will be the digital roll-outs with APN Outdoor ((APO)) targeting 14 large format boards in the second half of the year and the conversion of two large format boards on Sydney's Military Road. AdShel has flagged the roll-out of its national roadside digital network of 270 screens from this month and oOh!Media ((OML)) has recently won a contract for 26 large format Sydney boards.

Real Estate Classifieds

New listings in the Australian property market stabilised in September with growth similar to the 4.0% rate seen in August, Deutsche Bank observes.  Sydney volumes remain strong with its growth rate continuing in the mid teens (16%). While Sydney and Melbourne accounted for 37% of the new national listings in September, the broker estimates they contributed well over 50% of the revenues for property classifieds.

With data now available for the first quarter of FY16 the broker estimates volumes were up 6.0% year on year and should support both REA Group ((REA)) and the Fairfax site, Domain. This reinforces Deutsche Bank's Buy ratings for both stocks.

Debt Collection

Encore Capital is a US debt collection house and the world's largest debt purchaser and is buying a 50.25% stake in Australia's debt recovery agency Baycorp. Oceania Capital Partners and SAS Trustee Capital have sold the stake but will remain shareholders.

The transaction implies a valuation of Baycorp of around $66m. The industry is largely led by price and unlikely to grow materially over the coming years,  Ord Minnett observes. Hence, the broker envisages significant risk that returns on equity will decline in the medium term.

The broker believes it would have been difficult for Encore, or indeed another foreign player, to enter the market on an organic basis. The acquisition of the Baycorp stake provides the company with access to historical data and systems in Australia.

Nevertheless, Ord Minnett has concerns that the cost of capital Encore enjoys and the relatively smaller presence that Baycorp has in the Australian purchased debt ledger (PDL) market could mean substantial pressure on returns for all incumbents over the medium term.

Global Growth

Commonwealth Bank economists have reduced global economic growth forecasts for 2016 to 3.1% from 3.5%. This is well below the the long-run average of 3.7%. An extended period of weakness in the large emerging market economies is considered the main reason behind the reduction.

Brazil and Russia are in recession and central banks in China and India are easing monetary policy to combat weak growth and low inflation. The economists expect more easing by these central banks before the end of this year.

As well, the economists reduce their US GDP forecast because that economy is expected to hit capacity constraints in 2016. They still expect the US Federal Reserve will begin tightening monetary policy in December. That said, the pace of tightening in 2016 is pared back, given global growth prospects. The commencement of higher interest rates in the US will be a watershed, as the last policy tightening cycle started over a decade ago.

Meanwhile the 10-year surge in global mining investment is easing but continues to deliver an increase in supply. This is expected to pressure prices and maintain low inflation in most economies in 2016. The economists expect only the central banks in the US and UK will tighten policy in 2016. They flag the risk of a 1.5% official cash rate in Australia and 2.0% in New Zealand.

Fixed Income

The impact of the global financial crisis is still being felt some seven years after it was spearheaded by the Lehman Bros collapse. Long-term government bond yields in the advanced economies are well below levels that can be explained by the outlook for growth and inflation alone, Standard Life analysts contend.

External headwinds are also affecting the US Fed's ability to steer its own path on interest rates. Still, the analysts expect that as long as the recoveries in the advanced economies become more self-sustaining and emerging market economic conditions do not deteriorate further, a gradual normalisation of monetary policy in the US will materialise.

The analysts suggest the benchmark US 10-year government bond yield will peak at 3-4% during the current economic expansion, well below the peak in previous cycles. The disconnect between yields and domestic growth is also not confined to the US. Bond yields in Japan, Germany and the UK have diverged significantly from growth.

Standard Life analysts also contend that, just as policies in the US, Europe and Japan are gaining traction, emerging markets are faltering. China has loosened its monetary policy and allowed its currency to depreciate. This is pulling commodity prices and global inflation lower and putting upward pressure on the US dollar. Any further deterioration in emerging market conditions would pose a significant barrier to higher long-term rates in the US, the analysts believe.

Surfstitch

Surfstitch ((SRF)) remains a key pick for Bell Potter. The broker expects 40% revenue growth in FY16, with continued strength in customer engagement and improving gross margins. Margin expansion is expected to flow into FY17 from the $12.5m in earnings and capex synergies extracted from the global re-branding and integration.

The broker judges the stock to be relatively good value when compared with its overseas peers on metrics such as enterprise value/sales, enterprise value/earnings or price/earnings. The broker believes the current discount at which the stock is trading is far too steep for a business where earnings growth is forecast at over 100% for the next two years. Bell Potter has a Buy rating and $2.25 target.
 

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article 3 months old

Weekly Broker Wrap: Electronics, Supermarkets, Insurers, A-REITs, House Building And 3P Learning

-Citi lowers economic forecasts
-JBH, DSH benefit from Apple boost
-IAG stands out in personal lines
-Moderation in housing, building likely
-Oz advantage as players shy from Macau
 

By Eva Brocklehurst

Leading Indicators

Citi's domestic economic barometer has shown signs of deterioration over the last three months in keeping with global leading indicators which have also softened. The broker's economists have reduced growth forecasts for a wide range of countries, the fourth consecutive downgrade to year-ahead forecasts. In Australia, the interest rate-sensitive housing sector appears to be peaking and there remains more downside to come for mining capex.

In contrast, labour indicators are more positive and confidence measures are lifting with the change of Prime Minister, so these more favourable signs should limit downside risk to growth, in Citi's view. Inflation is expected to stay low and a tentative bottoming in the rate of decline in the terms of trade could signal the downward momentum in profit growth is peaking.

The broker's leading indicators suggest more downward adjustment in the Australian dollar and no further change in the cash rate.

Consumer Electronics

Apple has apparently sold more than 13m units of the new iPhone worldwide in the three days post its launch. This is a new record, Deutsche Bank observes, and bodes well for the retailers. The Australian Bureau of Statistics in September last year specifically called out the launch of the iPhone as factor in the 10.6% increase in electronics retail sales.

JB Hi-Fi ((JBH)) and Dick Smith ((DSH)) are considered to be the primary beneficiaries but Harvey Norman ((HVN)) should also gain a fillip.

Supermarkets

Deutsche Bank observes that the Woolworths ((WOW)) store network has aged considerably over the past few years and become older than the Coles ((WES)) network. In addition to price and value perceptions, the broker believes this is a key reason behind the underperformance of Woolworths.

Deutsche Bank's analysis suggests that the 80-plus per annum refurbishment target will modestly improve the situation but there needs to be around 120 per year to restore the network to where it was 3-4 years ago. Around 41% of Woolworths' stores are less than five years old while around 60% of Coles stores fall into that bracket. This is even more acute when considering that Woolworths has rolled out new stores more rapidly.

Australian Insurers

Morgan Stanley has surveyed 3,700 motor and home insurance customers. Strength in personal lines stands out for Insurance Australia Group ((IAG)). To date the company is successfully managing the risk of dilution from Coles to its incumbent brands. IAG locks in customers with multi-policy discounts and has the best cross-sell in home and motor. Its customers are also the least likely to shop around on renewal and it takes greater discounts to persuade them.

Suncorp ((SUN)) has a lower cost strategy but appears challenged, given recent 3-4% price reductions have failed to deliver a higher share of new business, Morgan Stanley observes. Rate increases are now being sought but this risks opening the door to challengers.

Next to IAG, Suncorp's main source of growth is its own brands. As the company simplifies its platform and extracts scale from vertical integration Morgan Stanley suspects it risk further diluting the multi-brand strategy.

After building a reputation for sharp pricing the challengers have delivered lower than average savings, with Youi seen holding back on discounting in 2015. The impressive growth in motor insurance share has paused, stagnant at 13%. Still, the challengers are well placed to advance their share, Morgan Stanley observes, particularly as Suncorp raises rates. Meanwhile, online brokers remain with just 5.0% of sales in both home and motor insurance.

A-REITs

Australian real estate investment trusts (A-REITs) performed strongly over the past week, in contrast to the broader market weakness. Credit Suisse observes the index generated a 0.6% return compared with the broader markets 2.5% decline.

The best performers were Goodman Group ((GMG)), Mirvac Group ((MGR)) and Federation Centres ((FDC)). The worst performers were National Storage REIT ((NSR)), Abacus Property ((ABP)) and Growthpoint Properties ((GOZ)). Credit Suisse expects sector earnings growth to remain stable at 4.4% over FY15-17 with the greatest acceleration from Westfield Corp ((WFD)) and the greatest deceleration from Dexus Property ((DXS)) and GPT Group ((GPT)).

Housing

UBS finds the question in the recent consumer sentiment survey of whether now is a good time to buy a dwelling worrying. This measure has slumped to a 5-year low while, when asked where the wisest place for savings are, the share of respondents citing real estate rebounded to a 12-year high.

Residential approvals are near a record high so, even as commencements ease back in 2016, dwelling investment should lift in coming quarters before flattening in the second half of 2016.

Price growth has likely peaked but UBS does not expect a large drop, given record low interest rates. Adding auction clearance rates into the mix, these are seen falling amid tighter macro-prudential policy and enforcement of foreign investment rules. Still, clearance rates are at solid levels and hardly indicative of a weak market. Overall, the UBS economists expect a moderation in housing strength rather than a downturn.

Building Materials

UBS explores the question of when the housing market does eventual turn. The broker calculates 10% decline in detached housing starts and 35% decline in the number of high rise, which would take total starts back to around 150-160,000 from the current level around 220,000. Boral ((BLD)) and CSR ((CSR)) are the most sensitive to this scenario.

Gypsum wallboard is most vulnerable in terms of product as its sells well into both high rise and detached housing. Data on product segments suggests only 20% of concrete/cement/aggregate volumes are sourced for housing which, if true, would make Boral less vulnerable, comparatively.

Bricks, tiles, insulation and glass would also be negatively affected much more by detached housing changes than by high rise. Land profits would be delayed by a fall in property markets.

For Boral, the US and Asia are expected to continue ongoing growth. For CSR, the aluminum business is the main problem and biggest concern for UBS. Both companies are likely to be looking at how they can invest to ease the exposure to Australian housing as the cycle inevitably moves on.

Gaming

Macquarie is confident that Australian operators can gain a greater share of the Asian VIP market, boosting domestic mass and VIP gaming revenue. The broker is negative regarding the Chinese VIP market, as tightening credit conditions weigh on the high rollers but regional destinations should pick up the players that are shying away from Macau.

The depreciating Australian dollar should support more visits from Chinese tourists, with excess capacity in most properties encouraging more junkets. Macquarie expects Chinese tourists will account for 32% of domestic gross gambling revenue.

Echo Entertainment ((EGP))) is consider the biggest beneficiary of an increase in VIP share. Macquarie estimates, if Echo Entertainment was to hold its current share and Australia lifted its share of the Asian VIP market by a further 1.0%, there is 4.6% upside to earnings estimates. For Crown Resorts ((CWN)) this calculation would boost base earnings forecasts by around 4.0%.

3P Learning

3P Learning ((3PL)) is an online education company with a suite of software products for students in grades up to year 12. The stock has fallen 30% since mid May and provides an attractive entry point in Goldman Sachs' opinion. The broker suspects investors may have over-reacted to the lower FY15 licence numbers.

The move away from textbook learning to online and increased public spending on education supports a positive view of the stock. Goldman Sachs initiates coverage with a Buy rating and $2.49 target.

FY15-18 earnings growth is expected at a compound 27%, underpinned by the company's ability to increase prices increase penetration and cross-sell its products. The broker suspects the market is underestimating the growth potential in the US and UK as well as the upside in Australia.

Competition is substantial, given there are thousands of online education providers around the world. The risk is one could make a significant move into the markets where 3P Learning currently enjoys precedence.
 

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article 3 months old

Opportunity In Treasury Wine

By Michael Gable 

The US Federal Reserve not raising rates has had the opposite effect to what the pundits were predicting. We were hoping for a raise in rates and expected that to send the market higher, not lower as everyone else was predicting. By not raising, the market has only become more nervous with the continued uncertainty. It will move beyond it of course but for the short term at least we will continue to be directionless and any short term trading will be very tough.

A couple of weeks ago we mentioned how the lower Australian dollar will be one of the catalysts for our market to eventually trend higher again. This is because overseas money can now buy a market that has not only fallen 1000 points, but is even cheaper again because of the currency translation. We are starting to see evidence of this with a bid last Friday for Veda Group (VED) which is one of our holdings. The bidder, Equifax, is based in the UK and we expect to see more interest in Australian companies that have been sold down aided by the weaker Australian dollar.

Today we look at Treasury Wine Estates ((TWE)).
 


TWE has been nicely trending higher since the lows in early 2014. When it got near the 2013 high about a month ago, the shares were sold down for a few days. However, instead of the stock undergoing a further sell-off, it has managed to edge higher again. So, the 2013 high is unlikely to be a major problem for TWE. It just needs to use up some more time under that level and if can hold around here, then we could see it break to the upside, at which point traders may wish to follow it.


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

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

Michael is RG146 Accredited and holds the following formal qualifications:

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

Disclaimer

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

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article 3 months old

Premier Investments Flags Large Smiggle Expansion

-Mature brands weigh on growth
-Advantage over peers with AUD decline
-Offshore sourcing flexibility a key positive
 

By Eva Brocklehurst

Premier Investments ((PMV)) has impressed with a solid FY15 result, defying many of the challenges that face fashion retailing. Consistent with prior years the company provided no specific earnings guidance but did flag the expansion of the Smiggle brand into Malaysia and Hong Kong.

The company is getting the growth and margin mix right, in Deutsche Bank's view, and the premium to the discretionary retail sector is warranted. Like-for-like growth was positive across all brands in the portfolio, while the UK expansion was progressing well.

The company has cited better sourcing and lower mark-downs underpinning its margins, while the higher margin Smiggle and Peter Alexander brands are also showing the strongest growth. Sales overall were up 6.4% year on year and the overall retail earnings margin was 11.2%.

UBS describes stationary supplier Smiggle as a "category killer", with limited true competition. There are now 188 stores and the company intends to open a further 16 in the UK prior to Christmas. The roll-out potential through Asia and western Europe is substantial. Premier Investments has set its sights on 50 Smiggle stores in Malaysia and Hong Kong by 2021.

UBS increases FY25 store count forecasts for Smiggle to 750. The broker estimates that Smiggle could generate FY25 earnings of $160m and a further 50% upside to total retail earnings if the brand expands to 1500 stores over the same period.

Citi finds the signs encouraging too and upgrades to Neutral from Sell. Smiggle accounted for almost half the sales growth in FY15. As the stock has de-rated over recent months, because lofty expectations for growth have been reined in, Citi believes a Neutral rating is now appropriate. While the growth prospects for Smiggle, and to a lesser extent Peter Alexander, are strong the other brands are considered mature and a weight on earnings growth.

The broker envisages fair value price/earnings for FY16 at 18.5 times. On FY16 estimates the PE is 17.9, adjusted for cash and the company's Breville Group ((BRG)) investment. Citi suspects better offshore sourcing is providing an uplift which is more than offsetting the falling Australian dollar hedge rate.

FY16 gross margins are expected to rise 30 basis points. Earnings margins are expected to stabilise around 11-12%. The broker makes modest downgrades to earnings estimates to reflect weaker input from the Breville stake and lower net interest revenue.

The premium valuation multiples, and the fact that 72% of sales come from mature brands, limits the opportunity to outperform, in Morgan Stanley's view as well. Hence, an Equal-weight rating. Core brands are highly exposed to the retail cycle and face increased competition from international entrants. This poses a long-term risk, Morgan Stanley suspects.

The broker forecasts 28% sales growth for Smiggle over FY15-18, driven by store growth in the UK and the entry into Hong Kong and Malaysia. There is also potential for another 10-15 Peter Alexander stores in Australia and New Zealand, which should provide growth for the next 2-3 years.

Nevertheless, by Morgan Stanley's estimates, new store contributions are substantially less than the existing portfolio average and implied like-for-like sales were actually in decline in FY15.

The broker accepts Premier Investments has a significant advantage over its peers when dealing with the sharp decline in the Australian dollar, because it can hedge two years forward. This should support gross margins over the next year and allow the business to offer competitive pricing to drive sales growth.

Goldman Sachs, not one of the eight brokers monitored daily in the FNArena database, finds no major change to expectations emanating from the results. Sales growth and store roll-out for Smiggle provide a small boost to longer term forecasts and are an attractive proposition, but the broker is cautious about the mature business and the ability to grow sales. A Neutral rating is maintained.

The database contains one Buy (UBS) and five Hold ratings. The consensus target is $12.47, suggesting 2.0% upside to the last share price. Targets range from $11.40 (Deutsche Bank) to $14.05 (UBS).
 

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article 3 months old

Weekly Broker Wrap: Mobiles, Retail, Insurance And The Australian Dollar

-Handset repayments need scrutiny
-Competition tougher for supermarkets
-Homemakers top non-food retail
-Majors lose share in life insurance
-Pressure on AUD continues
 

By Eva Brocklehurst

Mobiles

Mobile sector activity was modest in August, with price cuts by all four major operators. Macquarie expects service revenues can continue to grow over the medium term, given the increasing demand for data. Rates of growth may be slower, nonetheless. The broker believes the current trends warrant close attention with regard to revenue per unit and handset subsidies.

Optus ((SGT)) and Vodafone reduced monthly handset repayments by an average of 5.0% and 6.0% respectively over the last two months. This is a turnaround from a rising trend since 2013. Morgan Stanley also believes this should be monitored, as it could negatively affect industry profitability, particularly when combined with a weakening Australian dollar. Most handsets are priced in US dollars.

Both brokers will be monitoring the launch of the new iPhone this month, particularly in the case of Telstra ((TLS)), which continues to increase handset repayments on average. Morgan Stanley forecasts Telstra will maintain a 40% mobile earnings margin in FY16 and decreasing handset repayments would likely have a negative influence.

Retail

Australian supermarket margins are unwinding and Morgan Stanley concludes consensus estimates remain too optimistic. Global average supermarket earnings margins are around 3.0%, compared with 5.4% and 7.8% for Woolworths ((WOW)) and Coles ((WES)) respectively.

The broker lowers earnings margins for FY20 for Woolworths and Coles to 5.5% and 4.7%, respectively. Morgan Stanley observes that the discounters' market share in Australia is only just going back to 1990's levels, a time when Bi-Lo, Franklins and Food for Less were in operation.

Aldi and Costco may appear to be aggressively taking share but at the 15% forecast by FY20 this remains less than the share of 20% the formerly mentioned discounters enjoyed. Nevertheless, Morgan Stanley expects the two new arrivals will achieve a similar market share and the Australian market is over-estimating the ability of the established chains to react.

Morgan Stanley calculates that returns for Australian supermarkets are high by global standards but are now decreasing. This has attracted players into the industry with deep pockets and vast experience in operating in different markets, with low return hurdles and disruptive discounting models.

Meanwhile, in the non-food department, Deutsche Bank considers conditions are the best they have been for some time. Non-food retail is growing at its fastest rate since 2008, which the broker attributes to strength in housing and some benefit from a weaker Australian dollar. However, not all categories are equal. Harvey Norman ((HVN)) is the broker's top pick, given late-cycle benefits from its exposure to homemaker categories.

Flight Centre ((FLT)) is attractive because of its valuation and improving outlook, while Dick Smith ((DSH)) also appeals on valuation. Wesfarmers is not considered cheap enough, although a solid FY16 is expected. Myer ((MYR)) has fallen since its FY15 results and, while there is still execution risk, Deutsche Bank notes some balance sheet head room and upgrades to Hold from Sell.

Retailing is about to get harder, in Credit Suisse's prognosis. The household goods sector may have a relatively more favourable outlook and should remain strong over 2015. Growth is expected to slow in other areas with the broker noting both clothing store sales and groceries weakened through the second half of FY15.

JB Hi-Fi ((JBH)) was the only company in the listed household goods sector to record an expansion in gross margin in FY15 for its Australian operations. Credit Suisse warns that consensus earnings forecasts for FY16 fell consistently throughout the past 12 months for the majority of retailers.

Insurance

Macquarie has reviewed and ranked Australian general insurers on premium growth, margin, capital flexibility and risks. QBE Insurance ((QBE)) tops the order of preference, with currency and interest rate tailwinds. Suncorp ((SUN)) is second, with strength in value metrics and the best expense ratio. Insurance Australia Group ((IAG)) brings up the rear and appears constrained without an imminent capital return, amid concerns about profitability of opportunities in Asia.

Changes in the remuneration of life insurance providers will start to take place in the lead up to the effective introduction of new requirements from January 2016. As reform takes place and lapse/claim challenges settle, UBS believes AMP ((AMP)) is right to prioritise margin over growth.

There are no signs the major players are stepping up to take back market share in life insurance. The broker observes AMP, National Australia Bank ((NAB)) and Commonwealth Bank ((CBA)) have given up 4.0% market share over the past two years. UBS does not expect this trend will turnaround in the medium term.

As a result, in-force growth for the three remains in a negative 1.0% to plus 2.0% range. UBS accepts, as new remuneration structures gain broader market acceptance, this may change. Still, the broker continues to forecast low single-digit in-force growth for AMP out to 2018.

Australian Dollar

With China and the rest of the global economy likely to stay weaker for longer, Asian currencies will probably fall further, analysts at Commonwealth Bank maintain. The Australian dollar is now expected to ease to US65c by the first quarter next year. The analysts foresee a risk for a larger fall to US60c in 2016.

The main reason underpinning the downgrade to forecasts is a pushing back of economic recovery in China. 2016 GDP growth is forecast to be 6.5%, down from prior forecasts of 6.9%. The main drag on China is decelerating growth in heavy industry and poor export growth, reflecting weak external demand. A hard landing for China is not expected, however, because a significant amount of policy stimulus is in place.

Other reasons for downgrading forecasts include the fall out for Asian economies from the easing back of growth in China, and the likelihood of subdued commodity prices as global demand fails to recover swiftly, following the largest global mining investment boom in four decades which continues to generate increased global supply.
 

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