Tag Archives: Energy

article 3 months old

Material Matters: Coal, Gold And Iron Ore

A glance through the latest expert views and predictions about commodities. China and coal; ASX gold sector; outlook for energy sector; iron ore prices.

-Re-introduction of China's 276 work-days rule may underpin coking coal
-Rising oil price supports a better outlook for energy stocks: Deutsche Bank
-More growth than investors allow for in Woodside: Morgan Stanley
-Iron ore price likely to incentivise additional supply


By Eva Brocklehurst


The question of whether the Chinese government will re-impose the 276 work-days rule for Chinese coal mines is an important one for coking coal prices, Credit Suisse attests. Prime hard coking coal has fallen to around US$170/t, around US$35/t below Tangshan in price parity terms. Stronger steel production, as China enters its spring construction season, and the work-days rule being imposed at the end of March, are two factors that may help the price.

The thermal coal price is not yet in the government's target range, having hovered close to RMB600/t since the start of the year. For China to impose the 276 work days rule, the broker expects thermal coal would need to enter its targeted price range which is believed to be RMB500-570/t FOB.

Thermal coal is not yet abundant in China, with Credit Suisse noting stocks at the port in Guangzhou were depleted to 900,000 tonnes in the first week of February, the lowest level in the broker's eight years of recording the data.


The ASX gold sector has reported strong production in the December quarter, leading the way on cost improvements with 75% of miners, overall, beating Deutsche Bank's forecasts. The broker notes the sector has increased 12% in the last month, which compares with the US dollar gold price being up 4% and the Australian gold price being flat.

The best performing equities were St Barbara ((SBM)), Newcrest Mining ((NCM)) and Regis Resources ((RRL)). The broker expects the sector to be focused on organic growth and exploration over the next three months. Deutsche Bank updates its models following the December quarter production reports, downgrading Evolution Mining ((EVN)) and OceanaGold ((OGC)) to Hold and Regis Resources to Sell on valuation.


Deutsche Bank has become more constructive for the near-term outlook in Australian energy coverage, supported in its view by a much firmer and rising oil price. In 2017 the broker expects demand to outstrip supply on forecast, which underpins a forecast for US$55/bbl Brent oil for 2017, as excess inventory is a gradually depleted. The degree of adherence to OPEC's production cuts remains the key swing factor.

Longer term, new production is likely to be necessary from higher-cost regions and a price signal will be required for such projects to proceed. While spot LNG markets have recovered in recent months from stronger demand, the broker expects a medium-term oversupply as the build up in new LNG capacity accelerates.

The broker's top pick in the sector remain Oil Search ((OSH)) because of its high quality assets. Santos ((STO)) also features in the broker's preferred exposure, with its exposure to PNG LNG and strong leverage to a rising oil price. The broker also likes Caltex ((CTX)), which it believes is currently pricing in unrealistically low expectations.

Morgan Stanley believes there is more growth than investors allow for in Woodside Petroleum ((WPL)). The growth plans that are underway are likely to exceed expectations over time. The broker notes the company's low-cost and low-capex LNG assets have enabled it to re-position its portfolio over the past 12 months. These projects should drive production and cash flows from the beginning of the next decade. Production is set to grow to 96.1mmboe in 2018 and 100mmboe by 2019. This should lead to higher operational earnings (EBITDA).

The projects become key drivers of value over the next 12 months, in the broker's view, as the market is applying little value to them. Capital expenditure is expected to be stable, meaning free cash generation will improve. There is also spare debt capacity of over US$1bn in 2018, providing potential for capital management and this should become a focal point for investors in the latter half of this year.

Moreover, the broker believes the company's M&A strategy over 2016 was right and expects Woodside will focus on oil opportunities outside of Australia that are either producing or have near-term development potential. Morgan Stanley upgrades its valuation for Senegal, Scarborough, Myanmar and North West Shelf backfill. The broker has an Overweight rating and $40.00 target.

Iron Ore

Ord Minnett observes the drivers of the recent iron ore price rally to US$80/t appear to be a combination of Chinese demand, solid consumption in the rest of the world as China reduces steel exports, and relatively flat supply. The broker expects tight conditions to persist through the first half of FY17 but the price will eventually provide incentives for additional supply to come on line, and this could remove some of the current pricing tension.

Ord Minnett raises its 2017 forecast for iron ore to US$73/t but still expects a downward trend towards the year-end as supply grows. Overall, the broker expects major miners to add 71mt in 2017, with global demand growth of 43mt expected. While viewing the market as broadly balanced, the broker acknowledges a risk in the growth in non-traditional supply, with the incentive of higher prices.

Macquarie observes iron ore is the only steel-making ingredient for which prices are still holding up, as coking coal, manganese and steel scrap prices have all weakened from recent peaks. The broker expects prices will ease for iron ore now that the Chinese new year holidays are over, as supply is clearly abundant. Steel mills are expected to pressure iron ore sellers, despite the traditional post Chinese New Year pick up in steel output and demand.

Full year Chinese trade data shows total iron ore imports rose 7.5% in January year on year, while the broker estimates iron ore consumption rose by less than 1% last year. Indian iron ore exports also show the biggest response to higher prices, Macquarie observes, aided by the removal of low-grade export taxes and export bans last year.

While the Indian government has maintained export taxes of 30% on fines above a 58% iron grade in the February budget, the broker envisages India could still export 30m tonnes or more of iron ore at current prices.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Material Matters: Oil, Nickel And Metals

A glance through the latest expert views and predictions about commodities. Macquarie eases oil and LNG price outlook; Philippines throws another spanner in nickel works; China's looming capacity reductions.

-Oil market likely to become over-supplied in 2018
-Spot LNG prices likely to struggle to rise
-Indonesia the wild card as nickel deficit expectations ratchet higher
-China's capacity reforms expected to ramp up this year


By Eva Brocklehurst

Oil And LNG

Macquarie's analysts have updated forecasts for oil and gas prices. They expect tighter balances in 2017 will lead to a return to surplus in 2018 and 2019. Brent is expected to average US$57/bbl, US$56/bbl and US$61/bbl in 2017, 2018 and 2019 respectively.

The broker suspects supply will be reduced by the cuts from OPEC, even assuming only 50% compliance from non-GCC members. The six GCC members are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates.

This pricing stability has already allowed shale producers in the US to lock in hedges and capital. The broker calculates that as OPEC's cuts roll off, this will combine with US production to push the market into oversupply in 2018.

Macquarie lifts spot LNG forecasts for 2017 to around US$5.8/mmbtu from US$5/mmbtu to reflect a combination of market tightness and stronger demand. But this relief is short lived as the ripple effect of rising US oil production means greater gas volume must coincide with the completion of trains three and four at Sabine Pass and train one at Cove Point.

2017 will also mean the completion of the much-delayed LNG export facilities in Australia. With more supply entering the market the broker envisages spot LNG prices will struggle to be materially higher than US$5/MMBtu until the early 2020's.

In light of the reduced forecasts the broker believes those stocks at risk within the LNG market are those most exposed to contract re-negotiation. Lower oil and gas prices means reduced earnings across the board, and as a result Macquarie downgrades AWE Ltd ((AWE)) to Underperform.

The broker retains a preference for Oil Search ((OSH)) over Woodside Petroleum ((WPL)). The broker remains positive on Santos ((STO)), as it seeks to ramp up gas volumes from Roma into GLNG. Beach Energy ((BPT)) is expected to struggle to replace the decline within its PEL 91 and is the most exposed to oil of the stocks the broker covers.

Revisions to Macquarie's oil price outlook results in a 30 basis point reduction to Australian inflation forecasts. The broker now expects headline inflation to remain stuck below 2% until late 2018. A flatter petrol price outlook removes a headwind for discretionary spending in terms of consumers.

Outside of the energy sector, a lower oil price forecast should benefit energy input costs for companies, making budgets less strained. Lower oil prices will represent an avoidance of the transfer of income from oil consumers back to oil producers but non-oil energy export earnings could also be more modest, particular for LNG volumes, as the price is oil linked.


The Philippines government has shocked the nickel market by announcing the suspension, or closure, of all mines it had previously suspended, as well as a vast bulk of mines into place under notice of suspension in October last year. The minister responsible has announced that the government is averse to any kind of mining operation in functional watersheds and said it was a mistake to have approved such mines in the past.

On Macquarie's calculations, the closures affect mines which produced around 165,000 tonnes of nickel in 2015. The decision is not final since all miners may appeal directly to the president. Nevertheless it goes against expectations that many of the mines would escape closure. At this stage the broker calculates up to -70,000 tonnes of nickel may not be available for export to Chinese nickel pig iron facilities.

The decision comes in the wake of the Indonesian government's move to allow a partial relaxation of its nickel ore export ban. It remains unclear how much Indonesia's ore quota will be and Macquarie suspects a deficit of -40,000 tonnes of nickel in 2017, and -50,000 tonnes per annum thereafter, may be on the low side.

Until there is more information from both countries the broker is reluctant to calculate a new supply/demand balance. However, the net loss in 2017 of around -70,000 tonnes of nickel, as a result of the Philippines announcement, could easily be offset by at least 20,000 tonnes of nickel from other sources.

After the reversal of the Indonesian ban on export ore Deutsche Bank retracted its expectations for a squeeze on the nickel price. While admitting its first half average price forecast of US$12,250/t and full year forecast of US$11,750/t may look optimistic, post the Philippines closures there could still be upside from today's spot prices.

The broker had expected miners in the Philippines would avoid closures as long as appropriate remediation plans were put in place. The latest news suggests that the shutdowns account for around 50% of the country's nickel ore output.

On a 2015 production basis, this would amount to around -200,000 tonnes but, given that many of the mines was suffering from grade decline, the broker estimates the loss is more like -175,000t of contained nickel. The broker agrees the tonnage of ore allowed out of Indonesia is still a matter of conjecture but assumes 10m tonnes of 1.4% grade, amounting to 90,000t of contained nickel.

The broker would expect upside risks to its export assumptions should prices rally but for now the net effect is seen removing 80-100,000 tonnes of nickel from the market and pushing up the 2017 deficit to -150,000t from -50,000t.

Metals China

China has emerged as a major producer of metals and now accounts for around 20% of global supply. Goldman Sachs believes that the government is determined to curtail capacity considerably and that the oversupply of China's commodities may be much more limited than widely perceived.

The country is ramping up its structural reform on the supply side by removing marginal capacity, amid reforms to increase industry concentration while restructuring zombie firms to prove quality and efficiency.

Aside from a continued focus on coal and steel, Goldman Sachs expects reforms to extend to cement and aluminium this year. If steel capacity curtailment overshoots - as it did with coal in 2016 - the broker envisages a risk the steel market may experience a shortage in the first half this year. Also the potential for aluminium capacity cuts should support aluminium prices.

Western miners are unable to pick up the slack as mining capital expenditure among the majors is at the lowest it has been in a decade and a lack of investment in new growth over the past three years has meant there is limited ability to flex volumes.

Goldman Sachs believes these factors should support commodity prices remaining elevated for longer, assuming demand remains intact. The broker cites a preference for Australian stocks Newcrest Mining ((NCM)) and South32 ((S32)) among its globally preferred mining stocks.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Material Matters: Iron Ore, Oil And Tin

A glance through the latest expert views and predictions about commodities. Iron ore optimism; oil market re-balancing; and a rally in tin.

-tight steel market expected to support iron ore prices
-observable down-trends in oil production and inventory needed
-semiconductor growth sees demand for tin surge


By Eva Brocklehurst

Iron Ore

Optimism in China's steel industry is the main driver of iron ore prices over the short term but the domestic iron ore industry could also have an impact on prices, keeping these around current levels in 2017, ANZ analysts contend. Iron ore is expected to be affected by the country's policy on industrial over-capacity. China's State Council announced last year it would reduce steel production capacity by 150m tonnes by 2020.

China is also intent on eradicating illegal steel making capacity as it battles pollution and emissions in its major cities. Hence, tightness in the steel market should support iron ore prices and the analysts expect underlying Chinese steel demand to remain robust in 2017. Steel production growth is expected to contract this year, although be matched by a similar fall in growth the net exports from the major exporters.

Growth in exports of iron ore from the Australian producers, Rio Tinto ((RIO)), BHP Billiton ((BHP)) and Fortescue Metals ((FMG)) is expected to fall to its lowest level in five years. Another indicator underscoring this expectation is the forecast from Australia's Bureau of Meteorology for an above-average number of cyclones during the local season, which lasts from November to April. This, the analysts suspect, could impact exports by as much as 15% quarter on quarter.

Still, the main potential game changer for iron ore is the Chinese domestic industry. Since iron ore price highs of US$180/t were encountered in 2009-14 Chinese output has fallen by more than 60%, as the high cost producers shut down when the price fell below US$100/t.

As iron ore prices have pushed above US$80/t in recent weeks, the analysts observe this raises the possibility of a recovery in Chinese iron ore production. If supply pushes up to when prices were last at this level, another 50mt of iron ore capacity could potentially be reactivated in China, in turn sending prices back below US$60/t.

Yet, the analysts believe the probability of this occurring is relatively low, as exporters have established strong relationships with buyers in China and now provide nearly 90% of the country's total iron ore consumption.


UBS has reduced its long-term oil price assumption to US$70/bbl from US$75/bbl. This reflects a view regarding the cost of developing a marginal barrel outside of the US, although the ultimate range could vary from US$60-80/bbl. Assuming reasonable compliance with OPEC output cuts, the physical oil market appears under-supplied for the second quarter of 2017.

The speed of a US response to the OPEC production cuts suggests significant tightening is most likely a 2018 event. The main uncertainties, the broker envisages, revolve around US shale and its capacity to ramp up quickly and be the marginal producer as conventional supplies decline globally. Other variables include the return of Nigerian supply and whether annual demand continues to grow at over 1mmbbl/d.

The reduction in long-term oil prices has reduced the broker's forecasts for earnings per share for the oil stocks. The broker expects oil companies to be conservative regarding organic investment in 2017 and mergers and acquisitions are again likely to feature.

UBS retains a preference for Woodside Petroleum (( WPL)) with its modest gearing and low-cost LNG production as well as Origin Energy ((ORG)), with its ramp-up of APLNG and and rising electricity prices. The broker has reduced its rating on Santos ((STO)) to Neutral after the recent equity raising and and downgraded Horizon Oil ((HZN)) to Neutral after a 35% rally in the share price.

Shaw and Partners also expects the market to rebalance if OPEC delivers on its supply cuts. The trends are already under way with non-OPEC supply falling and demand remaining robust. If OPEC delivers then this should underpin an oil price recovery in 2017. The analysts note inventory levels are still near historical highs and, without OPEC cuts, it would take around two years for the oil market to rebalance.

With oversupply, the value of marginal production is zero, and there is no reason to spot prices to rally. The analysts believe, for the current rally to continue, observable down-trends in production and inventory data are needed. OPEC and non-OPEC cuts, if delivered, should eliminate up to 1.8m bpd of supply and result in deficits through 2017.

The analyst expect this would result in meaningful reductions in inventories throughout the year, for the first time in four years. Assuming demand remains robust the market should "normalise" by the end of the year, Shaw and Partners estimates.


The lowest volume metal of the base metals traded on the London Metal Exchange, tin, was second only to zinc in terms of its recovery in 2016, rallying 45% to trade at US$21,000/t by the end of the year, Macquarie notes. Refined stocks of the metal in warehouses are at low levels, although producer inventories have lifted and mine supply appears to be improving, notably in Indonesia.

Key reasons behind the recovery in the tin price include low visible levels of stock on exchanges and reduced export volumes from key producer Indonesia, as well as lower production in China and Myanmar. The broker estimates Indonesian mine production was down 13% in 2016 after price-related mine closures at the start of the year.

While Indonesian production looks to be improving, Macquarie suspects Myanmar production growth is slowing. Meanwhile, Chinese metal output was affected from July by environmental shut-downs and data up to October implies there has been no real recovery.

The supply developments are not that dynamic and the broker concludes the 2016 rally was mostly driven by one factor that did change dramatically, demand. There was a surge in end-use semiconductor shipments in the second half of 2016 while tinplate production was boosted by stronger-than-anticipated demand from the Chinese steel sector. Together these two features account for around two thirds of global demand.

Moreover, Macquarie's semiconductor analysts are projecting global sales growth of 9% in 2017 on a continued recovery in the sector, particularly with wafer fabrication capacity being added aggressively. The broker upgrades its outlook for demand, which should push tin into a deeper deficit over the next few years. Accordingly, price forecasts are raised on average by 5-21% out to the end of the decade.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Bullish Outlook For Liquefied Natural Gas Ltd

By Michael Gable 

The S&P/ASX 200 Index has eased back over the last week as predicted, but there is still some life in the small and mid-cap space. US markets were closed overnight and with Trump being inaugurated on the 20th, it is likely to be a quiet week. One of our recent trades in Sandfire Resources (SFR) is now showing signs of making the next step higher, and we also identify another trading idea with Liquified Natural Gas Ltd ((LNG)) breaking out and looking very bullish.

Most of 2016 was a base building exercise for LNG, except for a brief spike up in June. It now looks like the stock is on the move again, with it on the cusp of breaking out of this year-long base. It looked like it was building up towards a move during the last few weeks, finally breaking out of an ascending triangle last Thursday. It then followed through with a big move up last Friday on volume. It is now finding some resistance here just above 80c, but it looks it poised to retest the high 90c levels again. If it can crack that, then we expect it to make a move towards $1.20. Traders are advised to trail a stop with LNG to see how far it can go.

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


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.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Uncertainty Over Woolworths Fuel Dogs Caltex

Caltex has provided 2016 profit guidance, prompting some brokers to review their numbers, but uncertainty remains linked to the Woolworths fuel business.

-Strong marketing earnings envisaged stemming from margins, as volumes down around 1%
-Better transport fuel volumes and premium fuel margins appear offset by "externalities"
-Market likely pricing in worst possible outcome from the loss of Woolworths fuel business


By Eva Brocklehurst

Caltex ((CTX)) has delivered its guidance for 2016 profits and created a divergence in the views of brokers, although there are suggestions the plethora of numbers makes analysis confusing for the market.

The company has outlined guidance for net profit, on a replacement cost of sales operating (RCOP) basis, of $500-520m. Excluding certain “externalities”, underlying RCOP EBIT (earnings before interest and tax) guidance is $820-850m.

At the EBIT line the guidance is better than Ord Minnett had forecast, because of a stronger refiner margin. That said, the broker takes the opportunity to review its investment thesis and downgrades to Lighten from Accumulate.

More conservative estimates are incorporated with a view that the risk from the potential loss of Woolworths ((WOW)) petrol volumes is not sufficiently discounted in the share price.

The broker would become more constructive at a lower share price that provides valuation upside for the existing business, and incorporates more of the downside risk from the loss of Woolworths petrol volumes.

Credit Suisse takes a different view. The broker acknowledges the various aspects to the company's guidance are confusing, yet considers the marketing EBIT of $735m a "cracking" result, up 9% on the prior year.

As volumes are clearly down by around 1%, the marketing result is assumed to have stemmed from the margin, which many, in the broker's opinion, do not want to believe will increase. Margin keeps surprising the market to the upside, although Credit Suisse acknowledges it takes a more optimistic starting point.

Nevertheless, the broker is at a loss to justify the market reaction, and can only assume the market is comparing the non-underlying number to the underlying number that is usually assumed in most analyst modelling. An Outperform rating is reiterated firmly.

Citi notes better transport fuel volumes and premium fuel margins were more than offset by $35m in "unfavourable externalities ", which include FX and pricing lags. These externalities appear to be a cost more often than not, so the broker now includes $15m of additional costs in its forecasts.

Citi believes consensus forecasts failed to capture these losses and, hence, the market may look through them. 2016 earnings per share estimates are downgraded by 3% and 2017 and 2018 earnings per share estimates are upgraded by 7% and 2% respectively.

There was no update on the fuel business with Woolworths and the volume currently supplying retail fuel sites that would be foregone if the business was acquired by a competitor. Citi believes the market has already priced in the worst possible outcome, that all 3.5bn litres of fuel is lost, and considers this overdone.

There was also no update on capital management plans. The broker notes the stock has underperformed since its results in August, largely because of the risk of losing the Woolworths supply agreement if it does not acquire the business.

Citi considers the risk to its Buy recommendation is one of the timing around the news regarding Woolworths fuel. A deal is expected to be finalised by the end of the year.

Morgan Stanley observes marketing volumes show signs of modest declines, which match recent industry trends that suggest declining diesel volumes across Australia over the past few months. It appears to the broker that margins per litre are falling slowly.

Thus far, Morgan Stanley believes Caltex has done a good job in managing margin in the supply and marketing business. This may become more difficult if volumes were to decline at a faster rate.

Australian petroleum statistics appear to show diesel consumption is falling across the country at a rate of 4% per month. The broker concedes it is too early to know whether this is a short-term slip or the start of a longer term trend.

While wage under-payments by franchisees remain a risk, the company has been working with the Fair Work Ombudsman over the past year and has cancelled some franchise agreements where inappropriate practices were found.

The broker believes the company is on the front foot in managing this area, and there is potential for more service stations to be managed in-house over time, potentially increasing the cost of running the retail business.

Morgan Stanley considers the company is entering a challenging phase in the Australian economy, but over the longer term it has a strong track record of growing earnings in the marketing and supply business.

Guidance was below UBS forecasts. Again, the miss is attributed to the impact of these externalities that are particularly difficult to forecast. The move away from a 5% EBIT growth target a couple of years ago raised concerns that incremental growth may be more difficult to achieve, but it seems clear now to UBS that the company has more levers to pull.

Net debt forecasts of $450m are well below UBS estimates, although the broker's estimates were inflated by the inclusion of the Milemaker acquisition, which will not be completed until the first quarter next year. A better net debt position reinforces the view that Caltex has capacity to undertake another off-market buy-back if further acquisitions do not eventuate.

In terms of premium fuel usage, this continues to surge, as the broker highlights Vortex diesel volumes were up over 10% versus 2015. The main negative, UBS believes, is the impact of increased competition in commercial/wholesale markets on margins. The investment thesis is unchanged and recent weakness in the share price is attributed to concerns around the loss of the Woolworths fuel supply agreement.

FNArena's database shows a consensus target of $33.87, suggesting 14.8% upside to the last share price. This compares with $35.26 ahead of the announcement. Targets range from $27.50 (Ord Minnett) to $40.00 (Credit Suisse). There are four Buy ratings, two Hold and one Sell (Ord Minnett).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Material Matters: Oil, Coal, Copper And Steel

Oil outlook; copper demand; coking coal contracts; steel pricing.

-Positive news priced into oil sector
-Favourable trends to continue for copper
-Macquarie upgrades BHP, S32 on coking coal contract pricing
-Overall outlook bullish for miners, balance sheets in good shape
-Steel stocks expected to outperform


By Eva Brocklehurst

Oil & Gas

Oil prices are expected to recover in coming years, and signs of accelerating cost deflation in offshore and further productivity gains in US onshore compress Citi's oil cost curve. The broker calculates that the incentive price to meet future demand has reduced to US$55-65/bbl, down from US$70/bbl. Hence, long-term oil price forecasts are reduced to US$65/bbl.

Citi does not believe the sector is cheap any more. While Santos ((STO)), AWE ((AWE)) and Sino Oil & Gas ((SEH)) remain Buy rated, the broker downgrades Woodside Petroleum ((WPL)) and Senex Energy ((SXY)) to Neutral. Beach Energy ((BPT)) and Origin Energy ((ORG)) are downgraded to Sell.

The agreement reached among non-OPEC producers was more favourable than Macquarie expected. Cuts of a total of 582,000 barrels per day have been agreed, spread across 12 countries. After a near 25% increase in the spot West Texas Intermediate price since the recent low of US$43.32/bbl recently, the broker believes the majority of positive news is priced into both spot and forward prices.

Macquarie is not inclined to initiate any net short position until spot prices reach US$60/bbl, although acknowledges the risk/reward proposition of being long falls away above US$55/bbl. Negative news is expected to be limited until both execution and compliance with the new cuts are visible in January 2017 and the second quarter of 2017 respectively.

While the inclusion of several countries with natural declines has rightly brought the non-OPEC deal into question, Macquarie's analysis indicates that even after adjusting for these producers, it is still meaningful

. Nevertheless, the broker's modelling indicates the US shale response will be massive. Macquarie estimates exit-rate production growth of 300,000bpd at the current rig count, 600,000bpd at US$55/bbl and 1.1m bpd at $60/bbl.


The outlook for copper demand has transformed this year and Citi believes a favourable trend will hold up even over the long term. The three channels offering sizeable growth potential for copper are urbanisation, electrification and transport over the next 10-15 years.

Greater disposable income in China and India is likely to spur demand for consumer goods that tend to be copper intensive. Growing awareness and investment in non-fossil fuel power generation is expected to define the pace at which copper demand benefits from increased utility in this sector.

Asia remains at the forefront of copper demand, and the broker estimates consumption is likely to stabilise at around 16m tonnes per annum with further potential to improve over the next 10 years.

Coking Coal

Reports indicate the March quarter hard coking coal contract between Glencore and Nippon Steel has settled at US$285/t, which is US$100/t higher than Macquarie forecast. This comes despite spot prices falling to US$270/t from over US$300/t in just over a week.

The broker incorporates the contract price into its estimates for BHP Billiton ((BHP)) and South 32 ((S32)) which results in material upgrades to earnings forecasts for FY17 of 10% and 12% respectively.

The settlement price is the highest since the December quarter of 2011. Macquarie understands that the appetite of Japanese mills to push a hard bargain was lessened because increased more materials prices can be used as leverage with their steel customers.

Macquarie expects spot coking coal prices to fall further as the Chinese government has announced production-loosening measures and disruptions at key seaborne suppliers are being resolved.

Morgan Stanley has turned bullish on the outlook for coking coal, revising its 2017 price forecast up by 58%. Forecasts are also revised up 36% for thermal coal, 16% for iron ore, 13% for copper and 10% for aluminium. BHP and Rio Tinto ((RIO)) are both set to benefit and the broker retains an Overweight rating on the two, preferring BHP.

The positive industry view combines better-than-anticipated prices and ongoing productivity gains, which should deliver better-than-expected cash flow, debt reduction and potential returns.

A general expectation that commodity prices will move lower means most miners are reluctant to add supply capacity, and the broker suspects that this, in turn, may mean prices hold at better-than-expected levels for longer than expected. Ultimately, if there is enough incentive there will be a supply response but until then the likes of BHP and RIO should generate strong margins.

The broker notes large miners typically outperform during a reflationary period and rotation in the industry. The metrics look compelling if even half the spot price upside is captured, the broker asserts.

Ord Minnett also believes the outlook is bullish for the miners. The gap between 2017 spot earnings and consensus forecast remains large, suggesting the consensus upgrade cycle should continue in the near term.

Meanwhile, balance sheets are in good shape across the sector which means reporting season should witness a return of higher dividends and/or capital management.

Also, Chinese economic data remain supportive of commodity demand and buoyant prices. In considering these factors many investors that are underweight the sector are expected to neutralise this position heading into January/February, and this is another re-rating catalyst.


Morgan Stanley believes supply-side reforms in China will create more favourable pricing for steel worldwide. The broker is more confident that China can achieve its permanent capacity reductions of 150mt by 2020. The merger between Baosteel and Wuhan Iron & Steel also shows that the industry continues to consolidate, pointing to improved fundamentals over the next 3-5 years.

Morgan Stanley believes China's steel exports will stay in a range of 100-120mt over the next few years. While this will improve the fundamentals of the global steel industry overall, the broker expects steel stocks in China, Australia, Latin America, India, Japan and North America will outperform as the benefits of supply-side reforms are not fully priced in.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Santos Narrows Focus

Oil & gas producer Santos has clarified its intentions, hiving off non-core business to a separate entity to renew its focus on key projects.

-Cost reductions the crucial positive but operational issues remain to be addressed
-Downside risk exists for GLNG but market expectations largely re-based
-Will there be enough gas in three years time when GLNG is expected to run higher?


By Eva Brocklehurst

Oil & gas producer Santos ((STO)) is narrowing its focus to five key assets. These assets, primarily gas, include LNG interests, Cooper Basin and Western Australian gas. Assets to be treated as non-core include Asian, Western Australian oil and east coast gas (Gunnedah Basin). These will be run separately to the rest of the company.

The most positive aspect of the company's investor presentation was cost reductions at Gladstone LNG (GLNG) and in the Cooper Basin, in Ord Minnett's opinion. Still, there are operational issues which need to be addressed.

GLNG is expected to operate at 6mtpa for the next three years, versus its nameplate capacity of 7.8mtpa. This is largely because of delays in the ramping up of feed gas. Meanwhile, the Cooper Basin is supplying to onerous contracts rather than to a tightening domestic gas market, the broker notes.

Cash break-even has been lowered to US$39/bbl for 2016 from US$47/bbl at the start of the year. At spot oil prices, Santos is expected to generate around US$400-450m in free cash flow per annum and management expects debt to decline to below US$3.0bn by the end of 2019.

Ord Minnett believes the company's success will come from its drilling program. The Cooper Basin has been starved of capital, meaning production rates are in decline, while at GLNG, the asset is somewhat dependent on third-party gas.

Santos intends to increase capital expenditure at both assets in 2017 and success could go some way to remediating immediate issues, in the broker's opinion.

Macquarie sums up the news as a small shift towards core assets rather than broader changes. Further clarity was provided on GLNG regarding drilling, costs and capital expenditure, which are now forward looking.

The broker suspects 2019 could be a substantial year for the company. Santos is targeting a reduction in net debt of around US$1.5bn through operating cash flow and further sales of non-core assets.

A correction in oil markets is well under way, UBS believes, given two consecutive years of reductions to global investment and a sharp drop in US rig activity. The broker acknowledges Santos remains highly leveraged to an oil price recovery.

UBS suspects there is more downside risk around GLNG over the next five years but market expectations have now been re-based. The main risk is an over-reliance on Fairview for equity gas supply, which the broker believes could lead to additional investment as Fairview output declines.

UBS estimates 90% of GLNG equity gas supply is currently being sourced from Fairview. The non-core assets represent 13% of 2017 forecast production and 6% of group reserves, albeit just 3% of group asset value, which UBS now views as effectively for sale.

The broker reduces its PNG LNG expansion valuation to tolling revenue only, until such time as the company demonstrates it can attain direct equity participation in future LNG trains.

There is a fly in the ointment, in Credit Suisse's opinion. Despite capital expenditure guidance for GLNG being reaffirmed, the broker is unable to truly believe that it has, "magically", become the lowest cost, undeveloped 2P reserve in Australia.

The broker does not readily envisage more equity or third-party gas will be available in three years time, when the company expects the plant to run at a higher rate.

Credit Suisse refuses to believe she LNG development costs around US $1.90/GJ as guided. The broker acknowledges there are large inefficiencies in the old company and costs are clearly being taken out, and rightly so.

The broker remains troubled by a business which generates around US$450m in free cash flow at US$55/bbl, has around US$6.3bn in debt & liabilities and a 15-year 2P reserve life. Given the concerns, the broker considers its Underperform rating and $3.10 target are justified.

Such fears do not trouble Morgan Stanley. Drilling and cost efficiencies offer potential for reserve upgrades over time, the broker suggests. Costs are expected to fall further in the Cooper Basin in 2017, having been well down in 2016. Morgan Stanley believes Santos is at the start of a turnaround, which bodes well accompanied by a view of rising oil prices.

Deutsche Bank is also on this ticket, believing the company is strongly positioned to benefit from a recovery oil price which will drive de-gearing. The broker considers the warehousing of non-core assets should improve capital allocation and welcomes increased visibility on GLNG upstream gas productivity.

Positive momentum through this year and the reduction in break-even estimates for 2016 put the fear of an equity raising to bed, Citi asserts. Equity production capacity and third-party gas contracts still suggest to the broker there is sufficient gas to get to over 7.2mtpa in 2019.

Citi highlights that while the company did reduce its expectations for the Roma wells, with no reduction to reserves this supports a slower ramp up but similar future production levels. The broker suspects guidance is based on what is proven today, to avoid the mistakes of assuming Roma/Scotia goes to plan.

Given the company's plans to form non-core assets into a lean, stand-alone business, with a focus on maximising cash flow and/or an exit, Citi believes the process is less about realising proceeds and more about simplification. This should free up management's focus and remove around US$850m of abandonment liabilities to strengthen credit metrics.

FNArena's database shows five Buy ratings, two Hold and one Sell (Credit Suisse). The consensus target is $4.91, suggesting 15.0% upside to the last share price. Targets range from $3.10 (Credit Suisse) to $6.03 (Morgan Stanley).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Origin’s Planned IPO Sparks Downgrades

Origin Energy's decision to spin off upstream oil & gas assets is seen as sensible but brokers have rushed to downgrade ratings on valuation.

-Valuation of new company dependent on debt load, overheads and offtake agreements
-Divestment will aid a reduction in Origin's debt levels
-May foreshadow further divestments in LNG business
-Credit Suisse questions IPO versus a trade sale


By Eva Brocklehurst

Origin Energy ((ORG)) is preparing to spin off its conventional upstream oil & gas assets via an initial public offering of shares (IPO). There are few details at this stage but the IPO is planned for some time in FY17. It will include the interests in Otway, BassGas and Kupe and projects in the Perth, Cooper, Bonaparte and Canterbury basins.

Significantly, the company will contract all of the current gas resources held by these assets prior to the IPO. Upstream assets related to APLNG, as well as the Browse and Beetaloo interests, will be retained. The main factors brokers require to determine valuation of the new company are the amount of debt load provided by Origin, the extent of corporate overheads and the offtake agreements that will be reached prior to the IPO.

Hence, Morgans does not hold great conviction in its preliminary valuation range for the spin-off at $1.5-1.7bn. The indicative valuation range suggests the company will be able to pay down a meaningful portion of its $9.1bn in debt and the broker calculates the combined return on invested capital of the IPO assets does not clear the company's cost of debt. On the basis of these factors alone the broker believes the move to spin off the assets is a positive.

Morgans downgrades to Hold from Add, following a 40% increase in the share price since coverage was initiated back in April. Share price strength, plus the significant unknowns surrounding the new company, gives the broker the impression the stock is trading at fair value. An ongoing recovery in oil prices and smooth ramp up of APLNG are the key upside catalysts.

Credit Suisse is less of a believer in the fair value of stock and reluctantly downgrades to Underperform from Neutral. The broker does not believe the IPO will be accretive to value although considers divestment is strategically the right thing to do. The divestment will materially reduce the capital intensity of sustaining earnings, about which Credit Suisse believes Standard & Poor's has been too generous in assuming they can sustain the company's debt levels.

The broker does not envisage any conglomerate discount in Origin's share price currently, although assesses it a more investable business after the divestment. All up, Credit Suisse concludes that the starting point of the share price just feels wrong.

Outside of the valuation, the broker's main difficulty lies with the use of an IPO rather than a trade sale. The broker asserts that equity markets, bidding with no synergies, should never outbid a trade buyer. Other bidders may exist but, strategically, the broker believes Beach Energy ((BPT)) is the right suitor for the assets. Has it had a look in? The Cooper Basin is the only asset in common between the two companies but the broker calculates material corporate cost synergies exist versus a stand-alone IPO business.

Origin will put in place gas supply contracts between the new company and the energy markets business to replicate current supply. The transfer price involved will determine the relative earnings split between Origin and the new company, and thus the value of the new company. This is not a zero-sum game, Credit Suisse contends, given the market will likely apply a lower multiple to the earnings in the new company than it will to Origin's energy markets business.

To Macquarie, packaging all the assets into a single asset is logical versus the piecemeal sales program that was previously flagged, as it produces a business similar to other mid-sized oil companies. Importantly, it offers growth opportunities in the Perth Basin, Kupe and Otway through new developments.

The broker envisages scope to reduce overhead costs for Origin which equal or exceed the cost structure added to the new company. An IPO accelerates the restoration of the dividend and the size of the dividend, in Macquarie's opinion. The broker is advising origin and thus restricted on offering a rating and target at present.

The transaction does not, on its own, solve the company's debt burden but should be helpful, Deutsche Bank notes. Strategically, the broker believes this could foreshadow a future second step in LNG divestments, which may help crystallise longer-dated value. The broker does not expect this to occur until such time as both APLNG debt becomes non-recourse to Origin and there is sufficient debt amortisation to allow two companies to stand independently.

This IPO is no game changer, in the broker's opinion, as Origin's earnings will experience a corresponding decline and debt will remain elevated. The broker considers execution risks are reasonable, given the relatively mature and short-life assets, some of which have been the subject of unsuccessful trade sale attempts over the past 18 months.

The company has positioned its integrated gas assets as Australia's "largest onshore unconventional gas developer ", but did not rule out further divestments over time, Morgan Stanley notes. The broker considers the IPO strategy a logical one and awaits execution details next year, agreeing that how much Origin will realise depends very much on the contracts which will be procured.

Citi values the new assets at $2.5-2.8bn, based on a US$50-70/bbl oil price outlook, and expects $1.8-2.1bn of IPO proceeds to flow back to Origin, after corporate costs are allocated. The broker believes the main driver for the divestment is a belief by management that the stock is trading at a discount to fair value.

While AGL ((AGL)) is trading at a premium multiple to that inferred by Origin's energy markets, Citi believes this is justified as AGL has a stronger growth outlook and balance sheet, while Origin retains material exposure to oil and LNG markets through APLNG.

The broker notes a de-merger also does little to change the chequered history of project execution and asset performance in energy & petroleum markets and does not de-risk APLNG, while value will be lost through fees and the IPO process. Citi downgrades to Neutral from Buy and expects a meaningful re-rating of Origin's multiple may take several years.

Ord Minnett adds up the sale proceeds as possibly netting as much as $3bn. The downside is this removes the natural hedge for the gas retailing business, and it remains to be seen what contractual arrangements can be made.

The run-up in the share price means the stock is now trading in line with the broker's valuation, leading to a reduction in the rating to Hold from Accumulate. In addition, the broker believes cash distribution from the APLNG to Origin could underwhelm in the near term and be a headwind for the stock in FY17.

FNArena's database shows one Buy rating (UBS, yet to update on the announcement). There are five Hold ratings and one Sell (Credit Suisse). The consensus target is $6.27, signalling 0.5% downside to the last share price. Targets range from $5.40 (Credit Suisse) to $6.95 (Citi).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Material Matters: Outlook, Iron Ore, Steel And OPEC

Outlook for metals; iron ore outlook becoming more constructive; steel demand; the upcoming OPEC meeting.

-Supply restrictions, economic reductions should boost oil, coking coal, nickel, natural gas and zinc
-Sustained downturn in iron ore pricing looking less likely
-Chinese steel demand improving and more resilient than expected
-Oil market expected to move into deficit in 2017


By Eva Brocklehurst

Commodity Outlook

Goldman Sachs notes that historically, when the US and Chinese output gap closes and inflation begins to rise, this is a buy signal for commodities. Supply restrictions from policy actions should benefit oil, coking (metallurgical) coal and nickel in the near term, while economic reductions should boost natural gas and zinc. The analysts downgrade three and six-month gold price forecasts to US$1200/oz on a stronger cyclical outlook.

Morgan Stanley notes the shock of the US election is now passing and commodity prices are normalising, largely via currency adjustments. The broker suspects the proposal to rebuild US infrastructure is probably bullish for metal trades given the size of the US economy. The US economy currently consumes up to 20% of the world's metal ore supply and was the biggest buyer before China became fully engaged in global trade a decade ago.

The US remains heavily dependent on oil, lead and coal. Nevertheless, Morgan Stanley highlights that any lift in demand growth these particular commodities can probably be met by domestic supply. The broker calculates that a reasonable boost for the US economy would be one where consumption rates lift back to historical highs, which would represent a 2-5% lift in global demand for copper, aluminium, alumina, zinc and lead but little change to nickel.

Iron Ore

ANZ's analysts believe a sustained downturn in the iron ore prices looks increasingly unlikely. A combination of seasonally strong steel demand in China and risks for further supplier disruptions could mean the market enters a period of tightness.

Supply-side issues are seen having a greater potential impact on the market. Growth in exports from Australia have been slowing for some time but there are signs the slowdown will accelerate in coming months. Rio Tinto ((RIO)) recently announced it would shut its Hope Downs mine for two weeks in December to reduce operating costs and maximise cash. While a shut-down of this nature will only have a small impact, the analysts note this appears to signal a shift from the strategy of expansion at all costs.

Meanwhile, the potential for further disruptions over the southern hemisphere summer is also higher. The Australian Bureau of Meteorology is forecasting an above average number of cyclones in 2016/17 and the Pilbara coastline has a 63% chance of more tropical cyclones than average.

Goldman Sachs is also more constructive on the iron ore outlook in 2017. Demand has surprised to the upside in China after the credit stimulus earlier this year. Supply, on the other hand, was slow to increase because of delayed capital expenditure and operational challenges.

Besides the fundamentals, a rally in metallurgical coal prices and a weaker Chinese currency, as well as the risk-on sentiment after the US election, have also supported iron ore prices. Goldman Sachs upgrades its iron ore price forecasts for the next three months to US$65/t, six months to US$63/t and 12 months to US$55/t.

From 2018 and beyond, the broker revises up its long-term equilibrium price forecasts to US$45/t from US$35/t. The broker expects Chinese steel demand will weaken in 2018 and the iron ore inventory re-stocking process run into physical constraints. Political uncertainties at the macro level and elevated levels of port inventory at the micro level suggests significant risks to the broker's forecasts, and the high level of volatility seen in the market this year is expected to continue.


Macquarie's latest steel survey from China shows a broader based improvement in demand and sentiment. Domestic orders improved over the past month for Chinese steel mills and, while property and infrastructure demand for steel has eased, a clear improvement has been witnessed in the machinery and automotive sectors.

The analysts note steel mills continue to re-stock raw materials and coking coal inventory is falling on tight supply, while iron ore stocks are flat month on month. Despite the rise in raw material costs, such as iron ore and coking coal, steel mills report they are in positive margin territory and are maintaining stable capacity utilisation rates.

Goldman Sachs also notes steel consumption is more resilient than previously expected and demand for iron ore is likely to be supported by further incremental re-stocking across the steel supply chain.


ANZ analysts expect OPEC (Organisation of Petroleum Exporting Countries) will reach an agreement at next week's meeting in Vienna and observe money managers have been aggressively shorting oil as OPEC members have increased their output. This suggests the market remains unconvinced that the cartel will reach an agreement.

Yet the analysts note comments from various OPEC members signal an agreement is possible. Iran's oil minister has said it was highly probable that members would reach a consensus. OPEC production is near a record high, driven by strong output from Saudi Arabia and smaller members. Nevertheless, the analysts point out that any agreement must take into account Iran's production remains below its peak achieved nearly 10 years ago.

Prices have been trading in a tight range over the past six months, and strong support appears established around US$43-44/bbl. With positioning already so short, even if OPEC fails to reach agreement the analysts expect selling to be relatively limited. Instead, the risks are seen firmly skewed to the upside in the short term, with agreement on production cuts likely to mean prices test the highs seen in 2016, at around US$53/bbl for Brent.

The analysts estimate the market will move into a deficit in the first quarter of 2017, assuming OPEC cuts production by 750,000 b/d in the first half. Without production cuts the deficit would likely be delayed until the September quarter. This is because most members are pushing towards capacity and this should mean limited increases in output in 2017.

Stronger-than-expected demand growth and lower production from high-cost countries increases Goldman Sachs' confidence that the global oil market will shift into deficit by the second half of 2017, even with OPEC production at current levels. Thus, there is now stronger incentive for OPEC producers to halt inventory growth in the first half and normalise the current high level of inventories with a short duration cut to production, in the broker's view.

Goldman Sachs believes a cut to production would help OPEC grow market share by sidelining higher-cost producers and reducing oil price volatility, which would increase the valuation of members' debt and equity.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Weekly Broker Wrap: Outlook, Strategy, OPEC And Airlines

Commodities and economic outlook; outlook for equities; OPEC production meeting; outlook for airlines; and Netcomm's NBN contract.

-Commodity boost to budget expected to be undermined by low wages growth
-Oz equities still considered reasonably attractive versus very low interest rates
-OPEC deal should be forthcoming, with surplus scenario likely if it fails
-Noticeable improvement in domestic airline passenger growth and yields


By Eva Brocklehurst

Commodities And Economic Outlook

A surge in the price of a number of Australia's key commodity exports since mid year has been widely flagged to provide a boost to the nation's economy. This includes the additional revenue to the federal government coming from increased tax receipts. The spot prices of three key commodity exports, iron ore, coking coal and thermal coal have risen sharply this year and, more generally, Commonwealth Bank analysts note, the Reserve Bank's non-rural commodity price index is up 17% since June.

Nevertheless, weak wages are expected to be a drag on budget revenues. Annualised wage growth for the September quarter was 1.6%, well below the 2016 budget assumptions of 2.5%. The analysts suspect this will reduce revenues and may offset the gains from higher commodity prices.

The CBA analysts suspect the size and relative strength of the NSW and Victorian economies means economic data presented at the national level is masking weakness throughout the rest of the country. Economic activity in the two biggest states, along with strong dwelling price growth in Sydney and Melbourne, is likely to mean the Reserve Bank prefers to stay on the sidelines in terms of its cash rate. This is despite the fact the rest of Australia could probably do with more easing of interest rate policy.

The analysts note that, during the mining investment boom, Australia was referred to as a "two-speed" economy, where relatively high interest rates and a strong Australian dollar weighed heavily on the rest of the country, while Western Australia, Queensland and Northern Territory experienced full-blown growth. Now this “two-speed” feature applies again, but this time it is NSW and Victoria driving demand and employment growth.

UBS expects the headwinds which have buffeted the economic outlook in the past few years, such as falling commodity prices and the drag from falling capital expenditure after the resources boom, will ease. As such, Australia's growth is forecast to strengthen to 3.0% in 2017, before easing to 2.8% in 2018. Through 2018 UBS expects growth to retrace as the booming housing construction cycle goes into reverse and the initial boost from public sector expenditure fades.

Growth is forecast to slow to 2.5% by the end of 2018. Inflation is expected to remain subdued and only return to the Reserve Bank's 2-3% target in the first half of 2018. UBS expects the RBA to keep the cash rate on hold before starting to normalise rates with a 25 basis point hike late in 2018 to 1.75%.

Equity Strategy

UBS considers a large and/or rapid drop from current levels is a key risk to factor in for equities in the coming year. Australian valuations appear moderately expensive in absolute terms but the market is still reasonably attractive compared with what are very low interest rates.

Australian earnings looks set to move back to positive growth in FY17 after two years of negative growth but, ex resources, trends appear still quite constrained, UBS observes. The broker remains relatively neutral on the banks, which appear reasonable value while the issue of their capital ratios is pushed out beyond 2017. UBS remains overweight resources.

Deutsche Bank believes the current price/earnings (PE) settings are about right and envisages earnings taking the market 4% higher over the next year. On the equity side, yield stocks have moved in line with bond yields and no longer look rich, with the broker noting the excess dividend yield that yield stocks offer is now close to the six-year average.

The broker likes some yield exposure at these levels and key picks include Telstra ((TLS) and Sydney Airport ((SYD)). In terms of the value trade the broker favours low PE stocks and key picks are Macquarie Group ((MQG) and Suncorp ((SUN)). Deutsche Bank remains a little concerned about domestic growth and expects reductions in official interest rates in 2017.

Australian dollar weakness and the prospect of better US growth leads the broker to include US exposure and key picks include Aristocrat Leisure ((ALL)), Amcor ((AMC)) and Incitec Pivot ((IPL)). In housing the broker sticks with a positive view and key picks include Fletcher Building ((FBU)) and Harvey Norman ((HVN)).


Macquarie believes agreement on production reductions by OPEC (Organisation of Petroleum Exporting Countries) has a 60% chance of success when the cartel meets on November 30, with a low US$50 price range for oil in the event of success and low US$30 on a failure to make a deal. Most OPEC members are at, or near, their production plateau levels, which the broker observes has not been the case since 2014, and should make a deal more palatable.

The form of a potential deal is far from settled. If OPEC fails to agree, Macquarie expects it will lose the power to jawbone the market and be on its way to dissolving, while members would be locked into a crude production race. Failure would force members to maximise production, resulting in large increases from Saudi Arabia, Iraq, UAE, and, eventually, Kuwait.

In this scenario the broker believes OPEC could quickly arrive at 34.5m barrels per day and create an oversupply for 2017 and part of 2018. In Macquarie's view, lower non-OPEC production would not be enough to offset OPEC growth as a result of the failure to obtain an agreement.


Ord Minnett observes a noticeable improvement in domestic passenger growth and yields in September, and what appears to be a more disciplined approach to international airfares to and from Australia by competing carriers. These developments have positive implications for Qantas ((QAN)) and Virgin Australia ((VAH)).

The number of passengers flying domestically grew 3% in September versus the previous September, and represent an improvement on the 2% growth in August and 1% growth in July. This confirms the broker's view that the July-August period was hurt by events such as the federal election.

The broker estimates yields in September in some key routes rose by 3-18% but, while these numbers are encouraging, cautions that average yields across the first quarter of FY17 were still down by 2-13%. In international routes passenger numbers grew by 6% in August, while average yields across the September quarter ranged from down 20% to up 10%.

Netcomm Wireless

Netcomm Wireless ((NTC)) has announced a contract with the National Broadband Network (NBN) for the roll out of its fibre technology (FTTdp or fibre-to-the-distribution point). This technology strikes a balance between the higher speed, but more expensive, FTTP (fibre-to-the-premises) and a technically inferior, but cheaper, FTTN (fibre-to-the-node).

FTTdp uses more fibre than FTTN as it extends to the kerb outside a property. The company's contract is for roll-out likely starting in FY18, which means production needs to start several months in advance.

This is a significant contract for earnings and, accordingly, Canaccord Genuity increases EBITDA (earnings before interest, tax, depreciation and amortisation) estimates by 27% for FY18, while FY19 is increased by 21%. Importantly, in the broker's view, the company is now well placed to win future similar contracts overseas.

Arguably, FTTdp is a bigger opportunity than fixed wireless because it addresses the issues in metro areas, where the majority of the company's target market resides. Canaccord Genuity increases its target to $3.50 from $3.20 and retains a Buy rating on the stock.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.