Tag Archives: Consumer Staples

article 3 months old

Brokers Not Chicken About Ingham’s Outlook

Poultry producer Ingham's posted a robust maiden first half and brokers suspect prospectus forecasts may be beaten.

-Investors should be mindful of the potential drop in volume growth in the second half
-Cost reductions to drive earnings growth as revenue slows in the second half
-Leading position in a rational Australian industry with high barriers to entry


By Eva Brocklehurst

Strong volumes characterised the maiden first half for chicken producer, Ingham's ((ING)). Brokers suspect, given the split in the first half:second half in the prospectus that the company is on track to exceed FY17 forecasts.

First half operating earnings (EBITDA) of $95.2m were up 9%, and 48% of FY17 prospectus forecasts. Poultry volumes were very strong, increasing 12.9%. Volume growth is expected to moderate in the second half with the cycling of EDLP (every day low prices) initiatives in the major supermarket channels.

Cost Reductions To Drive Earnings Growth

While there is upside to FY17 prospectus estimates of around 2%, Citi advises investors to be mindful of a second half drop-off in volume growth, and the competitive environment in New Zealand. The main drivers of a good second half result, in the broker's view, will be more cost savings and operating leverage from higher volumes.

Citi notes the poultry supply chain is sensitive to changes in demand and the initial spike in pricing in early 2016 produced some pressures that will ease over time. This results in the benefit being delayed to the second half of FY17, While poultry volumes were up 10% excluding ingredients, Citi estimates prices fell -5-7% in Australia.

In New Zealand. on the other hand. while there was a decline in poultry volumes a better sales mix led to pricing growth. Citi believes evidence of a successful lowering of costs is the key driver of the share price.

Earnings are envisaged tracking 4-11% ahead of prospectus forecasts and 2-9% of Morgan Stanley's estimates. The broker also expects cost reductions will drive earnings growth, as revenue growth slows in the second half. Management expects Australian volumes will be in line with prospectus forecasts, which implies growth will slow in the second half to zero from 15% in the first half.

Macquarie believes the company is well on the way to achieving, if not modestly exceeding, prospectus forecasts. Valuation is undemanding and the broker expects confirmation of the sustainability of margin improvements will provide a catalyst for the stock to re-rate. Australian earnings margins increased 50 basis points to 7.4% in the half.

Macquarie notes the company also appears to have managed the fall-out from strong demand in key lines. The company is reported to be still in negotiations with one key QSR (quick service restaurant) customer. Industry feedback suggests this is McDonald's. The outcome of negotiations are not expected to impact the second half but Macquarie expects it might impact FY18.

NZ Conditions Remain Tough

Macquarie also believes the challenging conditions in New Zealand will remain a drag on the second half. Nevertheless delivery on prospectus forecasts is not predicated on a material turnaround in NZ operations.

UBS notes market concerns around the risk of rising imports for New Zealand were somewhat alleviated, as exports to Australia were down year-on-year. The broker likes the stock as the company has a leading market position in a rational industry that has high barriers to entry and attractive returns. There is margin upside as well. The broker believes the current share price is undervaluing the medium-term earnings opportunity.

Credit Suisse notes the competitive dynamics are very different between Australia and New Zealand. Oversupply is the main problem in New Zealand, while Australia is a more meaningful business because of its larger size and being the major beneficiary of the company's efficiency programs. The company's major competitor is also following a similar strategic path, such as increasing automation and focusing production on certain states while rationalising it in others.

The strong result has increased the broker's conviction that surprises could be on the upside. Results also affirmed the broker's view of the longevity of earnings growth beyond FY17. Although mindful of the supply chain challenges and some increasing seasonality, Credit Suisse suspects there is enough benefit from the higher volume base and efficiencies to enable FY17 prospectus forecasts to be beaten.

While the broker suspects some may view comments such as "Australian volume growth is expected to moderate" somewhat negatively, this comment needs to be taken in context of the strong first half. There are some reasons for caution but Credit Suisse believes there are enough drivers of growth to mitigate concerns.

FNArena's database shows five Buy ratings and one Hold (Morgan Stanley). The consensus target is $3.72, suggesting 12.3% upside to the last share price. Targets range from $3.40 (Morgan Stanley) to $4.00 (Morgans, yet to update on the results). The dividend yield on FY17 and FY18 forecasts is 4.0 % and 6.0% respectively.

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article 3 months old

Better Outlook For Woolworths Supermarkets

Industry feedback suggests Woolworths supermarkets had a better time than Coles over Christmas. Woolworths has also announced it will divest its petrol stations business to BP.

-More focus on sales versus margin at Woolworths, with turnaround in train
-Question of how Coles responds to Woolworths' improvements
-Woolworths petrol divestment to BP could help Metcash


By Eva Brocklehurst

Woolworths ((WOW)) increased both the frequency and depth of discounting in the Christmas quarter and the company appears far more focused on sales as opposed to margins, Morgan Stanley observes. Higher promotional activity and the successful launch of the loyalty program should boost second-quarter supermarket like-for-like sales growth.

The broker now forecasts Woolworths' supermarkets delivering like-for-like sales growth of 1.5% versus 1.0% for Coles ((WES)) food and liquor in the second quarter of 2017. This signals the first time since 2009 Woolworths has outstripped Coles. Morgan Stanley retains a Underweight rating, suspecting FY17 margins will be disappointing.

From its surveys of supermarkets, UBS believes the turnaround has begun for Woolworths and the projected pace of relative improvement versus Coles may prove too conservative. The question is whether, and how, Coles responds. Woolworths has lifted its overall score on the broker's survey and closes the gap to Coles, with a strong performance across the board. Importantly, Woolworths improved in key customer-facing areas such as price, on-shelf availability and in-store compliance.

Staff morale also lifted, which signals to UBS a better performing business with a clearer direction. To some extent these trends were expected, given the magnitude of the company's investment in this area over the past 18 months, but the pace of the turnaround has come quicker than that implied by UBS estimates.

The broker notes Coles still leads the market in its ranges, formats and marketing but that lead is shrinking. UBS expects sales at Coles to revert to mean unless it incorporates a strategy to again leap ahead of both Woolworths and Aldi.

UBS highlights the performance of Coles, with relative declines across all nine of the survey themes, does not signal the company is doing anything wrong, rather it means no change in the company's strategy to combat a better-capitalised and more customer-focused Woolworths, as well as the step-up in intensity by Aldi in fresh food. Should current trends continue, UBS believes Coles may need to react in the form of margin investment or capital expenditure, particularly given both Aldi and Woolworths are accelerating refurbishments.

Suppliers were clear in signalling to UBS that Woolworths traded better over Christmas and while the broker envisages only modest downside risk for Coles' like-for-like sales in the second quarter, the pace of improvement at Woolworths signals both sales and margins could recover more quickly than previously realised. Nevertheless, UBS has not made revisions to its estimates as yet. The test will be for Woolies to maintain the momentum in 2017 as price investment eases.

The fresh food sector was the only negative for Woolworths in the survey, a surprise to UBS. This is an area the broker hopes will improve, particularly given the investment Aldi is making in fresh food. The broker believes a price war is looking less likely as Woolworths has undertaken major investment and has signalled it would be more rational beyond the first half.

Moreover, input pressures are rising via raw material costs, logistics and labour and suppliers are also now forecasting flat shelf price inflation over the next 12 months compared with the 0.2% deflation noted in the June survey.

Macquarie revises its expectations for comparable store sales growth in the second quarter, reflecting its own feedback from a broad range of channel checks. While Woolworths has improved its execution on a very poor performance from the prior Christmas, Coles is likely to find further improvements a tough hurdle, given its outstanding execution in the prior year.

While the second-quarter performance is likely to favour Woolworths, Macquarie does not believe this is an indication of the medium-term trend. The broker forecasts comparable store sales growth of 2% for both companies in FYI 18 and FY19.

Increased competition and the use of loyalty programs, with improved availability of stock, are expected to dampen margins over the first half. The broker expects first half earnings margins at Woolworths food and liquor will decline around 50 basis points to 5.0%. Margins at Coles are expected to decline 16 basis points to 5.1%. Macquarie maintains an Outperform rating for Wesfarmers, given the upgrades to its resources business in its first half guidance, with a Neutral rating for Woolworths.

Woolworths Petrol Divestments To BP

On December 28 Woolworths announced it would divest the 527 fuel convenience sites it owns and the 16 development sites to BP for $1.79bn. The transaction is subject to regulatory approvals and is not expected to be completed earlier than January 2018. The deal will still provide Woolworths with a fuel offer and the potential to expand its convenience offer through BP.

Woolworths will use the proceeds to reduce its bank debt and, using FY16 continued operations data, Citi calculates the deal will be 1% diluted to earnings per share. Woolworths has announced that as part of the transaction, it will pilot a “Metro at BP stores” format and, assuming the pilot is successful, roll out up to 200 stores under the format.

As Woolworths does not currently participate in wholesaling, Morgan Stanley suspects BP will require an alternative supply of food products. In this case, as Metcash ((MTS)) supplies a significant proportion of the food for BP sites the company is well placed to expand its business.

Morgan Stanley believes the divestment of the fuel business is rational and will alleviate balance-sheet stress. It should dilute earnings per share by 4-5% on a full year basis, on the broker's estimate that the business is sold for 10 times earnings (EBIT) and based on Woolworths part funding petrol discounts.

The broker is unconvinced about the proposal for up to 200 stores in the metro format, given the lack of historical evidence on execution. Petrol stations either tend to generate profit by petrol being sold at barely above cost to drive traffic amid profitable food sales or they sell petrol at a reasonable margin with negligible food sales. They don't do both, Morgan Stanley attests. The broker awaits clearance from the ACCC and FIRB on the divestments before including the proposed transaction in its forecast.

Morgan Stanley suspects Metcash will be the main winner from this petrol deal as it supplies the existing 1400 BP petrol stations and Woolworths does not wholesale. The broker estimates revenue uplift for Metcash could be around $400m which, at a conservative 3% margin, equates to $12m of EBIT, or a 3.8% uplift with very little incremental capital deployed.

There is one Buy rating on FNArena's database (Deutsche Bank), with two Hold and four Sell for Woolworths. The consensus target is $22.31, suggesting -8.5% downside to the last share price. Targets range from $19.10 (UBS) to $27.00 (Deutsche Bank).

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article 3 months old

Can Ingham’s Deliver?

Brokers are crowing about newly listed poultry producer, Ingham's Group, but concede there are a risks investors should be wary of.

-Ingham's benefits from strong market share and high barriers to imports
-Risks in re-negotiating contracts with major supermarkets
-Demand expected to underpin double digit earnings growth


By Eva Brocklehurst

Poultry producer Ingham's Group ((ING)) has spread its wings to the ASX and several brokers have initiated coverage of the stock, noting its cheap price but highlighting the stock is not without risks.

In a market which is increasingly sceptical when it comes to IPOs (initial public offerings), Credit Suisse believes the stock will have to do more than just screen cheaply. It will need to deliver on prospectus forecasts and grow earnings thereafter.

The company will always face challenges in a competitive, mature industry, the broker acknowledges, but could surprise to the upside. The broker's conviction in this area is based on the strong market position, competent management and a plausible margin expansion program.

Ingham's is a vertically integrated poultry producer, in operation since 1918. Poultry comprised 87% of its FY16 revenue with the remainder being stockfeed sales. The company operates in the Australasian marketplace, which has a high restriction on competing imports and stiff quarantine procedures for disease mitigation.

This environment, as well as stable product demand, underpins broker confidence in the stock. The risks include changes to import rules, supply chain disruptions and changes to customer relationships. Ingham’s has long-term customer relationships and multi-year contracts with major retailers and quick service restaurants.

On the latter, Morgan Stanley is cautious. As contracts roll over there is a risk with re-negotiating with major customers. Woolworths (which the broker estimates provides 38% of Ingham's revenue) has invested $1bn in prices over the past two years, including over $50m in the chicken category.

Ingham's has been a beneficiary of this price investment via higher volume growth. While major contracts are in place until the end of FY18, the broker suspects, given Woolworths' strong bargaining position, that Ingham's may be forced to lower prices, effectively handing back recent gains.

While the valuation may be cheap, the broker emphasises that the earnings risk needs to be priced. Morgan Stanley prefers to assess valuation on an Enterprise Value/EBITDA (earnings before interest, tax, depreciation and amortisation) basis as the company has significantly more financial leverage versus its peers.

Ingham's is still in the early stages of cost reductions, including plant automation, labour productivity improvements, network rationalisation and procurement savings. Morgan Stanley estimates gross cost savings of $144m remain to be found. While cost cutting is the primary driver of margin expansion, operating leverage and premiumisation should also drive margins.

Morgans (not to be confused with Morgan Stanley) has few concerns, believing the leverage to attractive industry fundamentals is significant and the stock is undervalued. Consumer preferences for leaner meat means chicken is the cheapest and most versatile protein, accounting for two of the top five fresh products sold in Australian supermarkets.

As supermarkets continue to focus on the fresh category, and Ingham's has scale, it provides a degree of bargaining power when negotiating with supermarkets, in the broker's opinion. As an example, supermarkets funded the cut in the prices of BBQ birds and Ingham's was a beneficiary of the strong uptake since that time.

The broker expects demand should underpin double digit growth in earnings per share over the forecast period. Over time, the broker expects the stock to be placed in the ASX200. Still, Morgans acknowledges the key risks include the market power of the major retailers and the loss of a major contract.

Macquarie estimates 101% of average cash flow conversion in FY17, noting a dividend pay-out range of 65-70% of net profit is targeted. The FY17 dividend is expected to be franked. The broker does point out that the business is highly integrated and small changes or variations in upstream areas, such as breeder eggs, hatcheries or broiler farms can have a compound effect down the chain.

The company has highlighted that price competition in the wholesale market could persist for longer than expected, coupled with the fact its major Australian competitor (Baiada) is unlisted and, hence, has less pressure to deliver short-term results.

The low end of Macquarie's valuation range is broadly in line with the company's peer group and 10% above competitor Tegel. The broker believes a premium to NZ-listed Tegel is justified for a number of reasons, including relative scale and exposure to the larger Australian market, potential to narrow the margin differential and a lower reliance on export markets for future growth.

FNArena's database has three Buy ratings and one Hold (Morgan Stanley). The consensus target is $3.66, suggesting 15.9% upside to the last share price. Targets range from $3.40 (Morgan Stanley) to $4.00 (Morgans). The dividend yield on FY17 and FY18 estimates is 4.9% and 6.4% respectively.

Goldman Sachs, not part of FNArena's daily monitoring, has initiated coverage with a Buy rating and price target of $3.70. Underpinning Goldman's positive view is the anticipation of 12% EPS CAGR over the next three years, driven by the company’s "Project Accelerate" cost out program.

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article 3 months old

Broker Views Diverge On Metcash

Grocery, hardware and liquor wholesaler/retailer Metcash provided plenty for brokers to chew over in its first half results on a wide-ranging outlook for the stock.

-Cost reductions tracking to plan and continuing diversification away from food & grocery
-Roll out of Aldi expected to have significant impact on SA, WA in next three years
-HTH expected to provide material upside from the second half


By Eva Brocklehurst

Grocery, hardware and liquor wholesaler Metcash ((MTS)) provided something for everyone in its first half result. That is the opinion of UBS. It also reflects a wide range in broker expectations for the stock. Cost reductions were ahead of expectations and hardware synergies were upgraded following the acquisition of Home Timber And Hardware (HTH). Management has outlined a synergy target of $15-20m by the end of FY18.

Declines in top line grocery sales accelerated, down 4% ex tobacco in the half, but the company has guided to a lift in second half grocery earnings. Convenience stores are expected to be profitable in the second half compared to the $4.3m loss incurred in the first half. UBS believes the company is doing a good job, with cost reductions tracking ahead of plan and price perceptions improving.

While the business continues to diversify away from food, UBS believes this division will need to retreat further over time. The broker retains a Sell rating, noting cost reductions cannot last forever and the company is structurally challenged in the long term even though the turnaround strategy is delivering results for food & grocery the near term.

UBS expects that the roll out of Aldi into South Australia and Western Australia will have a significant impact on supermarket earnings in the next three years and Metcash has the most to lose, given its high 25-30% share of that market.

Macquarie highlights greater clarity for the second half earnings outlook and the synergy benefits from the HTH acquisition. While the first half was mixed in terms of food & grocery, much of this is blamed on the continuation of a poor performance in convenience that is now largely rectified. The broker believes the company's diversification strategy is beginning to deliver, with the earnings profile now being driven from the liquor and hardware divisions.

While competition may be tough, the company's agenda for cost reductions and its strategic plans continue to underpin growth of compound 8% over the next three years, in the broker's calculations. Macquarie believes that Metcash is the only one of the three supermarket stocks to be pricing in a discount war into it share price and maintains a Outperform rating.The broker expects HTH will provide material upside with its second half earniungs contribution expected to be over $10m.

The broker notes the company is shifting its focus on private labels towards a higher quality mid-range product and there is increased weighting of tobacco in the sales mix. While the increase in tobacco excise appears to have had a positive impact on Metcash at the sales line, plans for further excise increases are aimed at reducing consumption and this will be a risk for the company as it increases its dependency on tobacco sales, Macquarie suggests.

The company also flagged a material increase in multi-store owner activity in terms of acquisition, refurbishment and new store expansion in NSW. This is an important development, in Macquarie's view, given the company's under-utilised distribution centre assets in that state, and it addresses an under-penetrated market in NSW, particularly for differentiated premium retail formats.

Credit Suisse also notes that unless capital expenditure or restructuring costs are significantly higher, the company is likely to financially de-leverage quickly over the next several years. The main supports for the company's outlook, in the broker's view, are continuing store upgrades by independent retailers and delivery of cost reductions which improve the competitive position of the wholesale business. Credit Suisse finds some validation for both of these points in the first half result.

If food distribution earnings stabilise and growth is achieved from hardware and liquor distribution, the broker considers the stock would appear cheap at 10 times FY17 earnings per share estimates and retains an Outperform rating.

Deutsche Bank is at the other end of the spectrum with a Sell rating, believing the recently enlarged hardware business will struggle to grow sales as competitor Bunnings ((WES)) continues to gain share. The broker believes wholesale sales growth, ex tobacco, is the main indicator of the health of the company's core food & grocery division and this metric deteriorated sharply over the last six months.

The weakness is attributed to the usual structural pressures as Aldi rolls out in SA and WA and Woolworths ((WOW)) begins to recover. Deutsche Bank downgrades forecasts for food & grocery as well as liquor across the forecast horizon to reflect lower earnings margins in food & grocery and lower-than-expected growth in liquor.

Following the acquisition of HTH the company is re-naming the Mitre 10 stores, to encompass its wider business, to Independent Hardware Group (IHG). This group will operate in an attractive market in which a large competitor (Masters) is closing, Morgan Stanley's notes.

The market is fragmented and the broker believes there is a long-term opportunity to gain market share as well as turn around company-owned stores. The growth of IHG diversifies away from the supermarket industry and as the market begins to better understand the opportunities for IHG the broker believes that Metcash shares will re-rate.

Morgan Stanley believes earnings have bottomed in food & grocery, and hardware should deliver significant growth ahead. The broker notes customers are paying back loans more quickly and working capital is being managed more tightly, hailing these aspects as hallmarks of a business that is being run better.

Ord Minnett downgrades to Hold from Accumulate as the results, while ahead of expectations, were disappointing in terms of composition. Food & grocery revenue and earnings margins both declined and the outlook is considered challenging despite the assistance of the company's Working Smarter strategy.

While improved synergies with HTH are pleasing to the broker, these are considered incorporated into the aggregate hardware earnings outlook. Ord Minnett believes the competitive environment will consume much of the Working Smarter cost savings. While the company is executing well, the position of its customers, in aggregate, is not strong, and this will weigh on the competitive position of the wholesaler, the broker asserts.

FNArena's database has three Buy ratings, two Hold, and two Sell. The consensus target is $2.23, suggesting 6.6% upside to the last share price. Targets range from $1.60 (Deutsche Bank) to $2.80 (Morgan Stanley). The dividend yield on FY18 forecasts is 6.6%.

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article 3 months old

Weekly Broker Wrap: Jobs, Retail, Real Estate Listings, NBN And Equity Strategy

Employment numbers; consumer spending; slot manufacturers; real estate listings slowing; momentum in NBN share; is it too early to ditch yield stocks?

-Lower housing turnover foreshadowing weaker spending growth, Credit Suisse believes
-Aristocrat seen increasing share in North America, Ainsworth subdued
-Soft listings likely to have adverse impact on REA and Domain
-Telstra enjoying solid gains in NBN share, Vocus accelerating
-Bond yields unlikely to rise much and Deutsche Bank still values yield stocks


By Eva Brocklehurst


Commonwealth Bank analysts have examined monthly changes in employment, which show that annual employment growth has been propped up by two very big increases in October and November 2015. According to the Australian Bureau of Statistics, employment lifted by 49,000 in October and 65,000 in November. These very large monthly changes were both two standard deviation events, the analysts note.

While concerns abated about the reliability of the data with the passage of time, the analysts are reminded that these are now about to drop out of the annual calculations. They expect the annual pace of employment growth to slow to just 0.7% in November from 1.4% in September.

Such an outcome is expected to mean analysts and policy makers focus a little more on the pace of jobs growth and what this is likely to signal for output, inflation and rates.

Retail Consumption

Credit Suisse suggests, from its observations, that retail spending has stalled heading into the end of year despite official data that points to growth in labour income and solid gains in house prices. The broker believes the official data overstates the strength of the labour and housing markets and stagnation in consumer spending is consistent with an alternative view.

The broker observes a drop-off in housing turnover, even abstracting what is happening in house prices. Lower turnover foreshadows weaker spending growth, even if house prices do not fall. Credit Suisse suggests the Reserve Bank of Australia should pay more attention to the state of consumer spending. This is because the consumer still accounts for around 60% of GDP.

The broker's leading indicators point to slower spending growth in the foreseeable future, in part because labour and housing market conditions are softer than the official data suggests but also because turnover in housing is dropping away. Hence, Credit Suisse believes the RBA will need to cut rates further.

Slot Manufacturers

From a survey of the North American slot machine market in the September quarter, UBS notes that Aristocrat Leisure ((ALL)) added 815 leased games. The survey indicated that Aristocrat achieved 27% ship share in the quarter. This was 11% above its trailing 12-month ship share.

Ainsworth Game Technology ((AGI)) achieved 2.3% ship share in the quarter, 3% below its 12-month trailing average, which compares with 7% in the prior quarter based on the survey. The survey is consistent with the broker's view that Aristocrat is increasing its share in North America and provides further confirmation for Ainsworth's update regarding its soft quarter in the US.

Real Estate Listings

New listings in the national property market declined 3% in October, a slowing from the flat levels observed in September. This indicates a weak start to the second quarter and Deutsche Bank expects a continuation of this soft listing environment will have a further adverse impact on both REA Group ((REA)) and Fairfax Media's ((FXJ)) Domain. The broker lowers forecasts and price targets for both stocks to take this into account.

New listings growth in the capital cities was slightly lower than the national numbers, with Sydney continuing to show the most significant decline, down 16%. Melbourne was down 4%. The broker acknowledges this may simply be a reflection of a low point in the volume cycle rather than because of any structural factors.

UBS also notes a post-election rebound in residential new listing volumes still has not eventuated. This means there is downside risk to this broker's estimates for REA. Relative weakness in Sydney and Melbourne may impact overall yields for REA, given the higher absolute prices of depth products in these markets.

NBN & Telcos

From its observation of ACCC data, UBS gauges Telstra ((TLS)) continues to enjoy solid gains, with its share in the September quarter helped by the acceleration of the FTTN roll out. Vocus Communications' ((VOC)) share of NBN market growth is accelerating and UBS believes this reflects a strong portion of industry additions. As the company's NBN subscriber base builds, reducing churn will become an increasingly important driver of share growth, in the broker's view.

Shaw & Partners notes Telstra is defending its market share aggressively, adding 61% of NBN subscribers in the September quarter versus its market share of around 47%. Vocus is also doing well, the broker observes, adding 11.3% of subscribers versus its market share of around 7%. TPG Telecom's ((TPM)) quarterly additions are below its natural market share, the broker notes, although it is doing well in metro areas.

Goldman Sachs agrees that Telstra is growing its overall NBN share, now considered to be over 50%, while Vocus is building momentum. The broker highlights the fact that the latter's overall share is continuing to increase despite the company not looking to actively migrate existing subscribers to the NBN.

The broker also notes a relatively soft subscriber performance from TPG Telecom, offset by improved plan mix. Goldman believes up-selling to high-speed plans is important for the company's profitability in an NBN world. That said, TPG's iiNet looks to have had a soft quarter, with TPG's share in Western Australia declining by around 115 basis points to 38%.

Equity Strategy

Deutsche Bank believes it is too early to ditch yield stocks even though these have come under pressure in the past three months, coinciding with the rise in bond yields. The broker is not convinced yield stocks will fall further and believes it is appropriate to include a selection of these in portfolios.

The broker's US strategist highlights the still-substantial gap between dividend yields and bond yields. A hike to the US Federal Reserve's funds rates in December is considered likely, but the broker does not believe this automatically means bond yields should move higher.

In 2004 bond yields barely moved when the US Fed was raising rates, weighed down by a glut in global savings. Now the broker observes there is a glut of central bank liquidity. Money is leaving Europe and going to the US, which can keep a lid on long rates.

The broker notes a divergence with Australia, as the US Fed seeks to hike rates while the RBA is likely to cut. Deutsche Bank also detects some recent softening in the Australian economy, slower growth across retail sales, hours worked and credit. The broker does not envisage bond yields rising much, removing a catalyst for more under performance.

Yield stocks may even trade a little rich, given their scarcity value in offering a decent real yield. The broker's portfolio has a selection of Stockland ((SGP)), Telstra, Sydney Airport ((SYD)) and APA Group ((APA)).

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article 3 months old

Hard Yards Still Ahead For Woolworths

Woolworths delivered improvement in supermarket sales in the September quarter but brokers believe the hard yards remain ahead of the business.

-Questions raised over the sustainability of revitalised sales and the competitive response
-Supermarket turnaround expected to take longer and cost more
-Is there room for both Big W and Target?

By Eva Brocklehurst

Woolworths ((WOW)) delivered an improvement in Australian supermarket sales in the September quarter, a commendable development brokers believe, as it provides some indication that the company's efforts to turn the business around are delivering results.

Yet Macquarie observes the industry is full of suggestions that the market is becoming aggressive, which raises a question regarding how much of a free kick Coles ((WES)) has received previously while Woolworths was working through its other problems. On the other hand, the broker notes this also raises a question about the sustainability of revitalised sales for Woolworths.

Like-for-like sales grew 0.7% in supermarkets, and Deutsche Bank estimates Woolworths may have had better growth on this front than Coles during the quarter. The broker suggests the building blocks are in place for gradual improvement over coming quarters but suspects the market may be too optimistic about FY17 margins.

While price investment and more effective use of loyalty points to drive increased share from existing customers has worked, Macquarie has doubts about the cost and what this strategy will induce from the competition. The broker believes the market is pricing in an aspirational recovery in Australian food retailing that is unlikely. While a stock undertaking a turnaround could be expected to trade ahead of fundamentals, the valuation process demonstrates how much is factored in at the current share price.

Morgan Stanley also suspects the market has prematurely priced in a turnaround and this turnaround is being hampered by the significant level of price and promotional investment required to drive top line growth. The broker notes items per basket remain weak, which implies customers are choosing to cherry pick specials. Until there is a clear path to over 2% like-for-like sales growth, with a sustainable level of investment, the broker believes a turnaround is some way off.

Morgan Stanley expects Aldi will continue to obtain a greater share of the consumer's wallet and this will put continued pressure items per basket. Moreover, as as investors increasingly focus on the first half results, the broker expects Woolworths shares to de-rate. Morgan Stanley forecasts a first half EBIT (earnings before interest and tax) margin for food at 4.28%.

UBS acknowledges that on face value, like-for-like sales in grocery have turned up, but retains a Sell rating on the basis that earnings risk still exists for FY17. The broker expects a competitive response from Coles and Aldi, with the risk that pricing intensity rises and a price war ensues. The broker continues to expect Woolworths will lose share in food & liquor as intensity steps up at Coles, share loss slows for the Metcash ((MTS)) IGA chain and double digit sales growth continues at Aldi.

UBS assesses the sustainable medium-term EBIT margin for Australian food & liquor is 5% or less and Australia remains one of the most profitable grocery markets globally. This signals there is downside risk to EBIT margins for Woolworths, given a need to re-invest to regain like-for-like momentum. Woolworths is a good company, in the broker's opinion, but it will take longer and cost more to turn around.

Outside of the supermarkets, Macquarie notes Big W is guiding to losses again in FY17 and concludes that there is a strong probability that there is only room for either Big W or Target plus Kmart in the discount department store segment. The latter two are owned by Wesfarmers. At best, the broker suggests both Big W and Target may take longer than expected to find a base.

Credit Suisse, too, believes the risks at Big W increase to the downside in FY17 because of the impact of changes to range and a deteriorating trading environment. Big W reported like-for-like sales declined 5.7% in the quarter. Credit Suisse forecasts Big W will return to profit in FY18 as its range stabilises and results in a reduction in the cost of goods.

UBS assesses the Australian department store EBIT pool has declined over the past five years, driven by Big W and Target, and the sector's performance is largely a matter of shifting between players, ie a fixed-sum game. While its estimates imply this profit pool will grow at around 12% over the next four years, UBS accepts this may prove optimistic. The main risk is heightened competitive activity from international players such as Uniqlo, H&M and Zara.

On FNArena's database there are three Hold and three Sell ratings. The consensus target is $22.16, suggesting 5.7% downside to the last share price. Targets range from $19.10 (UBS) to $24.79 (Morgans).

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article 3 months old

Soft Quarter Signalling More Weakness For Wesfarmers

Brokers raise the spectre of whether soft September quarter sales numbers for Wesfarmers, particularly at Coles, are a sign of more weakness to come.

-Main negative is the deceleration of sales growth at Coles as Woolworths steps up price investment
-Sales growth at Coles now more difficult to obtain and expected to be modest
-Resources business seen doing the heavy lifting for Wesfarmers at present
-Uncertainties also prevail in the fashion, hardware and resources


By Eva Brocklehurst

Brokers raise the spectre of whether soft September quarter sales numbers for Wesfarmers ((WES)) are a sign of more weakness to come. Sales were weak across the main divisions. Food and liquor grew 1.8%, which represents the worst growth in several years. Bunnings slowed to 5.5%, as a result of clearance activity at former competitor Masters and a softer market, which are acknowledged to be temporary factors. Target's like-for-like sales slumped 22% while Kmart was encouraging, growing sales 8.2%.

The main negative was the deceleration in sales growth at Coles supermarkets. Management suggested this was driven by slower market growth as well as intense competition. Deutsche Bank warns there are risks in calling one quarter a trend, but believes competitor Woolworths ((WOW)) is improving in an environment where deflation is constraining market growth, while Aldi continues to gain share.

The broker does not believe there was a sharp market-wide decline in consumption volumes, but looking at the three consecutive quarterly declines in like-for-like growth, suggests this does coincide with the improvements Woolworths has made, even if it just means Woolworths is now “less bad”.

Overall, the broker contends that the sustained run at Coles has been supported by a strong top line, which has enabled the supermarket to provide incremental value for customers and grow or, at the least, preserve margins. Sales growth is now likely to be difficult to obtain, which could undermine this value loop that has been crucial to the success of Coles. With Coles being the main driver of Deutsche Bank's valuation the broker's rating is downgraded to Sell from Hold.

Cash generation is sound for Wesfarmers overall, Ord Minnett asserts. Bunnings is able to continue to generate a strong return on capital through continued earnings growth and capital recycling. The value focus and cost reductions at Coles are expected to position it well to address a challenging competitive backdrop. Still, the broker expects only modest earnings growth in the near term.

Industrial and resources divisions are improving, although this carries some risk and weighs on the price/earnings multiple in Ord Minnett's calculations. While accepting that blaming the weather is a weak stance, Macquarie's recent channel checks confirm the comments from Wesfarmers that a cold and wet spring has adversely affected apparel, home improvement and supermarket sales.

Resources business is doing the heavy lifting for Wesfarmers at present but it, too, was affected by weather, with total production down 11.8% on the prior quarter. The lower production will delay the benefit of higher coking coal prices but the company is expecting to break even in the first half. The first half is lining up as a tough period the broker believes, with risks to earnings increasing, but the longer-term proposition of strong balance sheet, earnings growth and dividend yield remain intact.

Macquarie is one of the more optimistic regarding Coles, doubting the supermarket has ceded share at this stage, although acknowledging it will need to to do more to offset the increased aggression in the market in recent months.

The broker does not envisage Coles straying from a long-held strategy of leading the market on value, which implies price leadership will not be given up lightly, although it could be at the cost to margins over the medium term. Macquarie forecasting a 10 basis points EBIT (earnings before interest and tax) decline in food and liquor over FY17 and slower comparable store sales growth of 2.3%.

Target's turnaround remains uncertain as brokers note the chain exists in a tough fashion segment. Credit Suisse expects around a 10% re-basing of sales in FY17 and, if Target successfully moves more towards an EDLP (Every Day Low Prices) model, the sale price offset could feasibly be around a three percentage point fall in markdown and supplier costs over time.

Credit Suisse would like to scrutinise the Woolworths and Metcash ((MTS)) results to determine the extent to which the slowdown in Coles was competitively driven. Pricing behaviour in food appears rational, given that Woolworths has dropped a significant profit into rectifying a poor price position. That said, the risk is that Coles moves its focus to near-term profit requirements.

Based on a circa 10% decline in fuel volume, the Coles convenience business has probably dropped 5-10% in value due to the acquisition of Shell's business by Vitol, the broker estimates. A reduction in the decline in gross margin offsets the earning impact of lower sales volumes in Coles in Credit Suisse forecasts for FY17.

Morgan Stanley reduces profit forecast for Coles by 12% and, while the non-food retailing business have also slowed, these are less of a concern given strong market positions. The broker reduces margin estimates significantly, estimating 4.6% for FY17 margins versus Woolworths at 4.4%.

The main question for UBS is what Coles does in the face of the heightened competition, considering it is driving the structural shift in the industry, as well as the impact slower sales will have on margins. The broker forecasts Coles to grow market share at 12 basis points per annum over FY16-20, yet also considers it increasingly challenging for Wesfarmers to maintain current rates of momentum in both Coles and Kmart into FY17. UBS believes Wesfarmers is fairly priced at current levels, given uncertainty over housing (Bunnings), grocery (potential price war) and the resources business.

The consensus target for Wesfarmers on FNArena's database is $41.59, signalling 1.8% in upside to the last share price. Targets range from $38.00 (Deutsche Bank) to $45.00 (Ord Minnett). The dividend yield on FY17 and FY18 forecasts is 5.0% and 5.2% respectively. There is one Buy rating (Macquarie), five Hold, and two Sell.

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article 3 months old

Treasure Chest: Bega Sell-Off Overdone

By Greg Peel

On Tuesday, Bega Cheese ((BGA)) admitted at its annual general meeting the company’s joint venture with Blackmores ((BKL)) to sell infant formula in China, launched in January, has failed to make inroads. As a result profit guidance has been cut.

Bega shares have since fallen 20%.

Saxo Group analysts believe the market has overreacted. Bega is one of few Australian listed pure-plays on the Asian protein trade and even fewer in the cheese business – feeding the emerging middle class of the Asian economies. Wealthier Asians are buying more meats and dairy.

On a technical basis, Tuesday’s sell-off represented a seven standard deviation move on 90-day volatility and the 14-day relative strength index (RSI) has also moved into oversold territory.

Saxo has taken a long position at $5.17 with a stop-loss order at $4.60 (noting risk of further capitulation) and profit targets at $6.00 and $6.50.

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article 3 months old

Caltex: The Battle For Woolworths’ Petrol Business

Speculation is mounting regarding the potential disposal of the Woolworths fuel business and Caltex has thrown its hat in the ring.

-Loss of Woolworths volumes unlikely to be entirely offset in the medium term 
-Opportunities for Caltex, given its competitive infrastructure network
-Concern the company may abandon capital discipline to chase the bid

By Eva Brocklehurst

Caltex ((CTX)) has confirmed its interest in the Woolworths ((WOW)) fuels business, flagging the submission of a conditional and confidential bid. Caltex is currently the exclusive supplier of petrol and diesel to the Woolworths fuel outlets.

The loss of 3.5bn litres in Woolworths fuels volume – the number confirmed by Caltex - out of the 15.7bn litres it sells, would be a significant negative, given the scale this provides to the operation of the infrastructure network, but Ord Minnett is one broker that is confident the company could adapt. The broker notes BP, according to press reports, appears to be favoured to win the business. BP has greater flexibility in its operating model as some operators run the store while BP as the head lessor, retains its branding and supplies the fuel.

Some of the implications brokers consider include the fact that any change of control of Woolworths fuel would take some time. The Australian Competition and Consumer Commission (ACCC) would have a keen interest in assessing the implications for the retail fuel industry and may require sites to be divested if BP wins the contract, which could then provide incremental sites for Caltex. Foreign Investment Review Board approval is also likely to be required.

Ord Minnett notes the Caltex infrastructure network has a competitive advantage, especially in Sydney and Brisbane, and it is unclear how BP would supply Woolworths in these markets. Caltex could also access a new loyalty partner. The broker notes two major alliances, BP and Velocity (Virgin Australia) and Woolworths and Qantas ((QAN)) (Frequent Flyer), are in play.

The loss of the Woolworths volumes is unlikely to be offset entirely in the medium term if Caltex loses but some volumes could be partially offset by growing third party distribution, and transport fuels margin per product is likely to expand while reduce in aggregate, in Ord Minnett's estimates. Moreover, Caltex has well flagged ambitions to expand its convenience operations and this may present an opportunity as key part of its medium-term strategic growth.

A review of Lytton refinery is also possible. The broker notes Caltex has been disciplined regarding the continued operation of Lytton, with a focus on strict financial hurdles. Finally, if Caltex were unsuccessful regarding the Woolworths business, another round of capital management to return some of the $850m in franking credits is possible. Caltex has stated it will be disciplined in its bid but there is downside risk if a competitor such as BP or Vittol is successful, as the fuel supply agreement could be terminated.

This supply agreement represents 22% of annual sales volume and UBS estimates it generates a margin of 2-2.5c per litre. The broker calculates the termination of the supply agreement could negatively impact EBIT (earnings before interest and tax) by $70-90m per annum, which represents 8-10% of forecast 2016 EBIT. Assuming an 18 month to two year delay before any supply agreement is cancelled the broker estimates $2.40-3.00 per share downside to valuation. In the event of success, upside will depend on the price Caltex pays and any further value uplift via synergies.

Credit Suisse cannot envisage any rational way, economically, that BP can outbid Caltex, but accepts the risk exists. Yet the risk to earnings per share is far lower than the actual volumes suggest and can be offset both operationally and through buy-backs, in the broker's view. There are plenty of growth options, too, for Caltex if it loses the Woolworths business. This is not to suggest, Credit Suisse emphasises, that it does not believe the business is a natural fit for Caltex.

The issue is about competitive infrastructure, which BP does not have in NSW and Queensland. BP has a small site in Newcastle and an agreement with Vittol at Parramatta and takes all its retail product from Caltex in south Queensland after closing Bulwer Island. Acquiring the Woolworths assets makes sense for Caltex but Credit Suisse would also applaud the company's capital discipline if it did not chase a deal at any cost.

The broker suspects there is a lot of competitive posturing going on between the seller and potential bidders. In a scenario where no company ends up buying the assets - where BP baulks at the economics and Caltex refuses to bid higher – the broker believes the loser is likely to be Woolworths.

Moreover, BP has been divesting assets aggressively in the past few years and has not allocated much capital downstream, and Credit Suisse considers it would be an unusual strategic step to spend a decent amount of capital on Australian downstream business to buy low-quality retail sites.

Citi believes the announcement from Caltex confirming the bid is an acceptance that it could lose the wholesale supply agreement. The fact that Caltex has also disclosed that the alliance and agreement are dependent on continued ownership of the sites by Woolworths is a signal to the broker that Caltex does not envisage it will successfully acquire the assets.

Citi agrees that losing the volumes would impact earnings, and could be partially offset by supply logistics services to the successful acquirer or by acquiring retail outlets that were forcibly divested by the rival to appease the ACCC.

Macquarie envisages a potential negative earnings impact of 3-12% on group EBIT should Caltex lose the agreement and is also concerned that the company's management may be pressured to overpay to secure the asset. On this subject Goldman Sachs is quietly confident that strong capital discipline will prevail at Caltex.

Questions for the broker centre on whether other bidders are competitive and whether the relationship with Woolworths is damaged by the push by Caltex into convenience retail. Goldman, not one of the eight stockbroker's monitored daily on the FNArena database, has a Neutral rating and $32.15 target.

The database shows two Buy and five Hold ratings. The consensus target is $35.34, suggesting 8.0% upside to the last share price. Targets range from $32.60 (Morgan Stanley) to $40.00 (Credit Suisse).

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article 3 months old

Supermarket Tug-Of-War Continues

Intense competition continues to plague supermarkets and brokers unravel the latest implications from food & grocery price surveys.

-Food price deflation likely to continue in the near term and Sept qtr growth driven by volumes
-Woolworths resists higher prices in fresh food while Coles discounts its packaged goods
-Citi queries and calculates sustainable margins for Australian supermarkets


By Eva Brocklehurst

Food prices remain weak, brokers observe, as the supermarkets continue to invest in price amid intense competition. Deutsche Bank believes Coles, owned by Wesfarmers ((WES)), is reinvesting the leverage from its sales growth, which makes regaining sales momentum more difficult for Woolworths ((WOW)). Aldi's rapid roll out in South and Western Australia adds another layer of intensity to the challenges.

On Credit Suisse's calculations, the growth rate in the supermarket industry was driven by volume in the first quarter of FY17. Price indices signal both Woolworths and Coles have experienced price deflation, year on year. The broker forecasts like-for-like sales growth of 0.3% at Woolworths and 3.8% at Coles in the September quarter.

Deflation at Coles did moderate. Online price indices signalled a fall to 2.0% deflation in the quarter from the 2.4% reported in the prior quarter. Higher prices for meat were the main reason deflation moderated, which partly offset lower prices for packaged goods.

Credit Suisse observes Woolworths has resisted raising prices in the meat category. Hence price deflation in the September quarter was 2.9%, high relative to Coles. and the supermarket appears to have aggressively discounted its fresh food categories.

The broker's in-store survey indicates the fruit & vegetable category at Aldi experienced high single-digit quarter on quarter price rises versus low single-digit increases at Coles and Woolworths.

Coles appears to have invested more heavily in packaged groceries, Deutsche Bank agrees, which is consistent with industry feedback suggesting it has become difficult for Coles to maintain sales momentum. The broker also observes Woolworths is investing heavily in meat, a key category as it is a driver of a larger basket size.

Overall, Deutsche Bank believes the market is becoming more competitive and expects deflation to persist. A situation where inflation returns to food is considered to be some time away as Woolworths' trading momentum is yet to turn around. Woolworths has demonstrated a willingness to invest incrementally and this could lead to further price deflation.

The broker adds that for branded and private label products, Coles has made a deeper investment in price compared with Woolworths. The difference is even more evident in premium products. Premium private label prices deflated 6.5% at Coles in the September quarter versus 4.8% at Woolworths.

Woolworths has begun phasing out its mid-tier Select brand to replace it with the Woolworths brand. Following its decision to discontinue the Homebrand label, to improve customer value perceptions, that product will be now be marketed under the Essentials private label brand.

On the other side of the tug-of-war the broker suspects Wesfarmers is employing the same strategy it has used across its other retail businesses, that is to reinvest the leverage from its sales back into price to make competitor growth more difficult. Deutsche Bank points to Bunnings and Kmart, suggesting that, if executed correctly, the successful business pulls further away from competitors with increasingly cheaper prices and stronger sales growth.

From the perspective of Deutsche Bank's survey, food pricing trends were largely unchanged in the quarter and there was 0.3% inflation. Food prices have now been very weak for six quarters. The broker estimates fresh food pricing deflated 0.7% in the quarter compared with 1.8% in the June quarter and, as is usual, this was driven by fruit & vegetables. Meat & seafood prices increased 0.5% at Woolworths while at Coles these prices rose 4.1%.

Citi undertakes a comparison of Australian supermarkets with the UK, noting that Tesco recently stated it aims for margins of 3.5-4.0% by FY20, up from 1.7% reported in FY16.

While the broker acknowledges comparing margins across retailers can be difficult, adjusting by excluding fuel, the FY16 EBIT (earnings before interest and tax) margin for Coles is calculated at 5.3% and Woolworths at 5.0%. This compares with 1.4% at Tesco.

As the difference in property ownership across the three is stark the broker prefers a comparison of EBITDAR (earnings before interest, tax, depreciation, amortisation and rent) margins. On this basis, Coles sits at 10.4%, Woolworths at 9.8% and Tesco at 5.4%.

In comparing the enterprise value/EBITDAR ratio of each retailer the broker makes a rent-adjusted calculation. Using FY16 results the outcome suggests Tesco trades at 7.1 times, Wesfarmers at 8.1 and Woolworths at 6.2.

Should Australia have higher margins for its supermarkets? Australian retailing is more consolidated, and while store formats and cost structures are similar, planning laws are more restrictive and population growth is higher. In sum, Citi believes profit margins should be around 100 basis points higher for Australian supermarkets compared with the UK.

Margins for Coles are expected to fall slightly but not collapse in the near term and the broker does not envisage a price war will be forthcoming. EBIT growth at Coles is expected to be subdued and this is the main reason Citi has a Sell rating for Wesfarmers.

FNArena's database shows one Buy rating (Macquarie), six Hold and one Sell rating for Wesfarmers. The consensus target is $42.71, suggesting 5.6% downside to the last share price. Targets range from $38.80 (Citi) to to $45.00 (Ord Minnett). The dividend yield on FY17 and FY18 forecasts is 4.5% and 4.8% respectively.

For Woolworths, there are three Hold and four Sell ratings. The consensus target is $21.06, suggesting 12.9% downside to the last share price. Targets range from $18.85 (Macquarie) to $24.79 (Morgans).

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