Tag Archives: Insurance and Finance

article 3 months old

More Pizza, Fewer Banks For Italy, Please…

Kathleen Brooks of City Index discusses why one small Italian bank could offer more substantial market risk than the referendum result.

By Kathleen Brooks, Research Director, City Index

So, Italian Prime Minister Renzi didn’t get to resign as he had planned to on Monday. Instead he’s been asked to stay on until after the Budget vote. This isn’t really significant for markets, he will go, we just don’t know when at this stage. After that it is likely that a coalition of centre-left and centre-right will come together to form a temporary government in an attempt to block the radical Five Star Movement from power. Of far more importance on Tuesday is the fate of Italy’s banks.

Some rare good news for Monte dei Paschi

The world’s oldest bank managed to swap over EUR 1bn of bonds into equity yesterday. This is where the good news ends, it is still looking for EUR 1bn in capital from the Qataris’, and without Doha as the anchor investor in this much-needed capital raising it is hard to see how Monte dei Paschi can avoid nationalisation. There have been reports that the bank is getting ready for some form of nationalisation at the weekend, so the clock is ticking for Italy’s third largest lender.

Why do Italian banks matter?

I often get asked why Monte dei Paschi matters for financial markets and risk sentiment, it’s certainly not as systemically important as other banks, for example Italy’s Unicredit, but Monte dei Paschi’s main problem is that it has become symbolic of Italy’s rotten banking sector that now relies on foreign capital for life support. If the Qatari’s decide against investing in it then it gives a terrible signal to the world about the ‘investability’ of Europe’s banks. Interestingly, in Europe it is not the systemically important banks that are the biggest risk to the financial sector, but the glut of mid-size banks that hold billions in bad debts that could endanger the health of the bigger banks in Europe, if contagion is to spread.

Bag a bargain, invest in Unicredit

Unicredit, Italy’s largest bank, is less of a concern, in our view. It also needs to raise EUR 13bn in capital, but its global reach, size and scope makes it a much more attractive option for foreign investors, such as rich Middle Eastern sovereign wealth funds. In fact, its weak share price - Unicredit has seen its stock price fall more than 60% in the past year - could make it an even more attractive option for investors with deep pockets, as it looks cheap. On Monday, Unicredit managed to sell its asset management arm, Pioneer, to France’s Amundi for more than EUR 3bn, which helped to limit its share price sell-off yesterday afternoon. Its CEO has said that it will update its capital raising plans on 13th December, if this contains positive news, then the markets could have hope that the big hitters in Italy’s financial system can whether the political storm.

More pizza and less banks

If Monte dei Paschi can’t attract foreign investors to boost its capital base then we would expect a sweetened nationalisation, something that protects the retail investors that hold the bulk of the bank’s bonds. This may not be what the EU had in mind when it envisioned banking union, but it will help stabilise the transition of power to Italy’s new government once Renzi resigns. Developments this weekend are worth watching. As we have said before, Europe would be mad to let Italy’s banks go to the wall, but that doesn’t mean that it needs to shut down some banks. Italy has more bank branches than pizzerias, in the future it desperately needs more pizza and less banks!
Interestingly, the investment world has known about the capital issues at Monte dei Paschi and other banks for some months, so why is it getting cold feet now; after all, the bank is in no worse shape now compared to where it was on Friday, ahead of the referendum. The reason is that bankers tend to see political events through a financial lens, hence why a No vote was considered so toxic to Monte dei Paschi’s attempts to woo the Qatari’s.

Why we haven’t seen risk sentiment fall off a cliff

In terms of the market reaction, the EUR has backed away from the 1.0770 high from earlier, but it remains in a strong position in the G10 FX space, and the reaction to the referendum has generally been mild. If Monte dei Paschi fails to attract investment from the Qataris’ then we could see the wind knocked out of the euro’s sails, however, we would still expect EURUSD to stay above 1.0500 in the short term. Likewise, Italian bond yields could also rise again, although we don’t expect to see the levels of panic in the Italian bond market like we did in 2012. Political risk matters, but as long as Italy’s banking sector can scrape together some foreign investment, mixed with a sweetened nationalised deal for Monte dei Paschi then we can’t see how Italy’s political woes can have anything other than a temporary impact on risk sentiment in global financial markets.

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Re-published with permission. Views expressed are not by association FNArena's (see our disclaimer).
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article 3 months old

Aussie Banks And The Yield Trade

In this week's Weekly Insights:

- Aussie Banks And The Yield Trade
- Rudi On Tour
- Nothing Ever Changes, Or Does It?
- Rudi On TV 

Aussie Banks And The Yield Trade

By Rudi Filapek-Vandyck, Editor FNArena

Australia's major banks have let Australians down too frequently in too many ways
[House of Representatives Standing Committee on Economics, review of Australian banks]

As of last Friday, the Big Four Banks in Australia accounted for 25% of the ASX200 with each of Commonwealth Bank ((CBA)), Westpac ((WBC)), ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) commanding the four largest index weight positions, led by CommBank's 8.34%.

Needless to say, owning the banks -yes or no- is simply not a question asked by too many funds managers because getting it wrong can cause too much of a negative fall-out. For most index-oriented professional funds managers, which is the overwhelming majority, temporarily moving Underweight or Overweight the banking sector is as far as the investment strategy is allowed to deviate from copying the major index on a day-by-day basis.

Most retail investment portfolios too are well-stocked with banking shares, including the more than half a million self-managed super funds (SMSFs). Here the culprit is a legacy from the past. For more than two decades, Australian banks proved an excellent and reliable investment vehicle, offering shareholders double digit returns in most years and attractive dividends plus franking in every year.

If you never sell to rebalance the portfolio, you end up being heavily overweight Australian banks and this is exactly what many a retail investment portfolio looks like. Stories of 80% or even 90% exposure to the Big Four are circulating regularly. And there is absolutely no appetite to sell, reduce, re-balance or diversify. Just ask any financial advisor who deals with self-managed retail clients.

A lot of this iron-clad trust and confidence among investors stems from the past. Since Keating's "recession we had to have" in the early 1990s, the Big Four Australian banks only cut their dividends once and that was during the Global Financial Crisis. Even then their cuts were limited to 10-15% and they were one-offs. (ANZ Bank cut earlier this year, but I'll get to that further down.) Clearly, there is a lot to be said about simply buying shares in all Four and let dividends accumulate and ignore share prices running riot in the short term.

This is exactly what Mike Macrow, a former banking sector analyst, has been doing since his retirement a decade ago. Macrow's personal portfolio has been 100% invested in the Big Four since, and with no intention of making any drastic changes today.

Banks Back In Favour

All of the above belongs to the past and the future is not going to repeat it. This is what many a banking analyst has been predicting since last year. For a while, it appeared their negative outlook was proving accurate. Bank shares were pretty much in the sin bin between May and February this year, but they've made a noticeable come-back post July.

Meanwhile, the Kommentariat in the fringes of the share market remains as divided as ever: Australian banks, yes or no? The answer depends very much on which angle we choose.

The yield trade, which has dominated underlying dynamics in global assets and certainly in the Australian share market in years past, is transitioning away from typical bond proxies into more growth and economic cycle oriented stocks. Australian banks, thanks to their relative undervaluation, have been benefiting from funds flowing out of REITs, Telstra ((TLS)) and infrastructure, thanks to low Price-Earnings (PE) ratios and high yield, supported by an international revival of banking shares on the back of a steepening yield curve in bond markets.

This is merely a short term view. If banks only source of solace is that they are benefiting from other bond proxies falling out of favour, then their short-term revival can just as easily be a short-term phenomenon only; a yield-trap for those who prefer the past over the future?

Even the most ardent supporters, like Mike Macrow, are not denying the good old days are over for Australian banks, and they won't be returning in a hurry either. Objectively assessed, things already started worsening years ago, and they have simply continued to trend downwards ever since.

The chart below, from a presentation by investment manager Alphinity, argues it all started going pear-shaped post 2009. But banks still had numerous levers at work in their favour, including ever lower interest rates, potential cost-outs and reserves for bad debts that could be reversed and added back to annual growth.

Five years later, however, most of those supporting factors have been exhausted, or they are close to, while the banks are also facing increasing scrutiny from politicians and regulatory authorities. This is the current phase on Alphinity's chart when credit growth remains low, past levers are either out of puff, or reversing, competition has heated and returns from the past can no longer be treated as a benchmark. All the while, the broader community in general is fed up with the wrong sales and profit-only culture and yet another scandal. This time it's about rigging the benchmark for the Malaysian Ringit.

Analysts at Morgan Stanley dedicated a sector research report on the "growing scrutiny of conduct and competition in the banking sector" with the analysts noting the banks are all responding by improving selling practices, addressing customer complaints, changing remuneration structures as well as protecting whistle blowers as they feel the need to placate broader communal unrest towards their cosy oligopoly in Australia. This could be beneficial to their customers (we'll have to wait and see) but for shareholders this translates into "higher costs".

Not exactly what the doctor would order at this vulnerable point in the cycle.

Admirable Dividend Track Record

One of the key features of Australian banks, and the reason as to why investors like Macrow are happy to put all their eggs in the sector basket, is that unlike banks overseas, Australian banks rarely ever cut their dividend. National Australia Bank, for example, which has consistently lagged the other three in terms of operational performance and shareholder returns since 2004, has kept its dividend at 198c per annum over the past three years.

Despite rumours, speculation and predictions to the contrary, NAB again paid out 198c over the financial year to September 30, 2016. As far as early indications go, NAB board members don't seem to show any intention of paying out less in the current year.

No doubt, it is this determination, shared by all boards across the sector in Australia, that allows the many Australian investors on bank shareholder registries to sleep soundly at night, knowing their investment is in good hands, with reliable income streams and tax franking offsets continuing to flow.

Of course, this is where the devil's advocate points out it wasn't that long ago when dividends at companies such as BHP Billiton, Woolworths, Fleetwood and Metcash equally looked sacrosanct, yet they have been cut, if not fully wiped out. Investors worried about their dividends from the Big Four banks should note BHP Billiton has no moat or pricing power and it took the worst commodities downturn in modern history to pull the board off what was an untenable promise to increase annual dividends no matter what.

Fleetwood fell victim to that same downturn, while Metcash is being squeezed by more powerful competitors, among them Woolworths, which has too many business units not performing, a structurally under-invested network, a vulnerable balance sheet and foreign competitors demanding their piece of the pie. None of these characteristics would apply to Australian banks, yet, it has to be noted, ANZ Bank did cut its dividend earlier this year by lowering the pay-out ratio.

So what does the ANZ cut tell us?

Stress Points And Capital Requirements

ANZ Bank reducing its payout ratio tells us that even when faced with extreme determination at Australian bank boards to not disappoint shareholders who became accustomed to annual growing dividends, it is still impossible to avoid the inevitable when the downturn persists and payout ratio and cash flow simply prove insufficient.

Australian banks have all pushed out their payout ratios to circa 80%. This is extreme by anyone's standard and makes their dividends vulnerable in case more bad news hits the sector. One area of concern is the pending downturn in apartment markets due to rising over-supply, another could be housing market deflation in Western Australia.

All Australian banks have significantly increased their exposure to mortgages since the GFC, yet it would require something out of the ordinary, like a global freezing of credit markets, as happened in 2008, or an economic recession, or a significant downturn for domestic property markets to force them all into a repeat of 2008 and cut their dividends through lowering payout ratios. Virtually no one with a credible voice on this subject is even remotely contemplating such a scenario, which doesn't mean it is 100% impossible, just a tad unlikely.

Yields on mortgage loans are rising and there certainly are indications stress on household finances is higher than what statistics suggest. Also, investors should not forget banks yet have to find out whether they'll need a lot more capital than can be raised through dividend reinvestment plans (DRP) and small sized asset sales. This question might remain unanswered for yet another year.

My suspicion is bank boards are hoping they can combine any bad news about shareholder dividends with potential bad news from the Basel committee internationally and APRA locally, so that the blame can be shifted onto the faceless regulators. Contrary to the capital raisings in 2015, any further raisings are likely to prove attractive buying opportunities.

Despite all these risks and headwinds, and the high payout ratios (except ANZ Bank), analysts researching the sector remain deeply divided whether or when any of ANZ Bank's peers will/should/might follow suit. Were the question being asked in any other country, there would likely be no room for a long-winded, undecided public discussion. However, given the unique characteristics of the Australian banking sector, including a high degree of pricing power and customer loyalty, the banks might, just might sail through all of the above without any damage to their dividend trajectory.

But shareholders should be aware "stable" and "unchanged" are now the new "growth". Plus, as far as I see it, all the effort and energy that is being spent on maintaining dividends at current levels at all cost virtually guarantees growth in profits will be tepid at best in the years ahead, if there will be any growth at all. Surely the banks could use any positive rub-off from China stimulus or Trump tax cuts.

Brian Johnson's Assessment

Last week, one of the veterans in the local bank analysts community, Brian Johnsonof CLSA, released his latest in-depth insights on the sector with colleague Ed Henning. In the report, titled "Sloth or Rat?", the CLSA banking team advocates funds managers should be sector Underweight. On an individual basis, only three companies in the sector deserve a positive rating, according to the report; Macquarie Group ((MQG)), CYBG ((CYB)) and National Australia Bank.

All others, including Bank of Queensland ((BOQ)) and Bendigo and Adelaide Bank ((BEN)) are either rated Underperform or Sell. CLSA analysts have long stuck to their view Australian banks require $27bn more capital in order to meet increased regulatory requirement (but this is at this stage no more than educated guesswork). In 2015 the banks raised $18bn in new capital.

In the report, Johnson and Henning line up eight crucial themes for investors in Australian banks:

1.) Notwithstanding the favourable impact of rising bond rates for US banks, the macro outlook for financial stocks globally remains challenging, in particular outside the USA. In Australia the banks have benefited from the initial phases of US quantitative easing but they have emerged as over-earning, over-distributing and their shares have been over-bought in extension of the AUD dividend trade.

2.) The Australian Prudential Regulation Authority (APRA) is not going to be soft on the banks. By late 2017 we will probably hear they need another $27bn in capital.

3.) Recent FY16 results failed to surprise. The forward EPS growth rate looks set to slow markedly.

4.) Warning: Sustainable bank dividend payout ratios are not linear; should earnings fall and capital intensity rise the sustainable payout ratio would fall. Any normalisation of earnings to mid-cycle and recapitalisation would seriously erode the dividend yields of the Australian banks. Under such scenario the report suggests dividend cuts of between 12%-24%.

5.) In the present context, Australian banks are likely less confident in pushing up lending rates, which will further increase pressure on Net Interest Margins (NIMs).

6.) Assuming we are approaching the end of the Australian interest rate cutting cycle, and longer term global bond rates are already rising, then the prospect of even a stabilisation in real asset values (let alone a decline) suggests Australian system credit growth could slow.

7.) Given the concentration of housing in Australian bank loan portfolios (ANZ: 43%, CBA: 58%, NAB: 51%, WBC: 61%) any bad news from local housing markets are poised to open up stress points across the sector.

8.) Australian banks seem reasonably priced, but not against a context of slowing earnings and stress points opening up. Rhetorical question from the report: Given that the EPS growth rate is set to slow and dividend cuts are likely the question must be asked what are the Australian banks actually worth? Also: History tells us that when it comes to banking you make the serious money on the last recapitalisation raising.

Special comment: Brian Johnson is one of the brightest amongst his peers, but this does not by definition extend to his stock picking abilities. He has been a long term fan of Macquarie Group, for which he was painfully off the mark when the shares approached the $100 mark back in 2007. He has been on the mark so far with his prediction CBA remains poised to lose its large sector premium.

Yield Trade Under Pressure

Australian banks have for a long while been the lazy man's option for investors in the Australian share market. There always have been more lucrative options elsewhere but pitted against the sector's solid track record, and the potential for making errors when switching to alternatives outside the sector, many investors felt safest to stay the course and simply ride out the bumps and troughs along the journey.

With many looking over their shoulder towards a rather rewarding investment strategy (even if it was in the past), it seems likely many are going to stay the course in the years ahead. This may well lead to an equally satisfying outcome, in particular with so many question marks about sustainable growth for corporate Australia.

Then again, it may not. Risks have risen. Market sentiment is like a one-eyed cyclops: only one focus at any given time.

For yield seekers, the dilemma stretches to high yielders whose share prices are under pressure every time bonds feel the jitters. And it's not like alternatives such as Kathmandu Holdings and FlexiGroup, both offering yields of 6%+, don't have their own challenges and risks.

From a risk-reward balance point of view, it is likely the better total return opportunities are with industrials offering 4%+ yield, but for many investors the risk for making an error is probably too high to contemplate making a switch. After all, Flight Centre looked like one such attractive option a year ago (and the year before that), and it's not like FlexiGroup doesn't know how to spell "disappointment". What happened to Telstra of late?

Maybe the conclusion from all of the above is that turning to equities solely for yield/income is now a less straightforward and riskier proposition. Contrary to recent price action, this also includes the banks.

Rudi On Tour

I will be presenting:

- Christmas Special for Chatswood members of Australian Investors' Association (AIA), December 14, 7pm

- To Sydney chapter of Australian Shareholders' Association (ASA), December 15, noon-1pm, Sydney Mechanics School of Arts, 280 Pitt Street

- To Perth chapters of Australian Investors' Association (AIA) and Australian Shareholders' Association (ASA) on 7 February 2017

- At the ASA Conference 2017, Grand Hyatt Melbourne, 15-17 May 2017

Nothing Ever Changes, Or Does It?

Yes, of course, investing in the share market is never really different and best working strategies today are the same that worked pre-GFC. Seriously. I tell you, seriously.

Now that we had a good laugh about it, let's get straight to business. This is a low growth environment. Has been since 2010 (it was masked at the time because of the V-shaped recovery from the global recession) and it is not likely to change fundamentally in the near term. I wrote a book about this (see below). This means investment strategies must adapt. You'll be turning your portfolio into a wish list for dinosaurs otherwise (and your returns will be a reflection of it).

Those not afraid to contemplate "this time is different" can subscribe to FNArena and read all about it in our bonus eBooklets 'Make Risk Your Friend' (free with a paid 6 or 12 months subscription) plus the freshly published eBook 'Change. Investing in a low growth world' (equally free with subscription, or available through Amazon and other online distributors).

Here's the link to Amazon: https://goo.gl/XVMzmP

See also further below.

Rudi On TV

- On Tuesday, around 11.15am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes
- On Thursday, I shall appear on Sky Business, 12.30-2.30pm
- On Friday, around 11.05am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes

(This story was written on Monday 28th November 2016. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's - see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).



Paid subscribers to FNArena receive several bonus publications, at no extra cost, including:

The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
- Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow. This book should transform your views and your investment strategies. Can you afford not to read it?

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article 3 months old

Ozforex Disappoints But Outlook Still Appealing

Foreign exchange business Ozforex provided a disappointing first half result but brokers suspect the issues that plagued the company are short term.

-Depreciation in British pound after Brexit dented results severely in the first half
-Acceleration in active client numbers expected in the second half
-Macquarie believes stock should be appealing at current levels


By Eva Brocklehurst

Foreign exchange business Ozforex ((OFX)) disappointed brokers with its first half results. Management commentary suggests the benefits of an increase in transactions in the lead up to, and immediately after, Brexit were more than offset by lower high-value volumes from the UK following the rapid devaluation of the British pound.

Interim profit of $9.7m was down 21.1%, reflecting a combination of weaker average transaction values and the ramp-up in spending as part of the company's Accelerate strategy. Management is now guiding for earnings to be down on the prior year while profit should be slightly higher. This compares to previous guidance for growth in full year earnings.

The results were always going to be difficult, Shaw and Partners believes. Not only is the company coming back from a failed takeover bid by Western Union, but it is building a new executive team and juggling a new mix of marketing. There is also the matter of the severe depreciation in the British pound in an otherwise low-volatility currency period.

The broker concedes the market is right to be concerned about a lack of growth in active client numbers, despite the significant boost in marketing spending, and also takes this opportunity to factor in more modest growth in its forecasts for new dealing customers going forward. Nevertheless, marketing expenditure so far this year should start to produce an acceleration in active client numbers in the second half.

The broker notes the market appears to be adopting a worst-case scenario. Shaw and Partners considers the company's target of $200m in revenue in FY19 as reasonable. While the broker does not envisage revenue growing quite that fast, expecting $169m, it notes that the company is guiding to an acceleration in transactions in the second half. There is also "locked in" growth in active client numbers as the long tail of previously acquired customers continues to trade.

Even with lower growth in active client numbers, the company has concentrated on higher transaction clients which have provided 10% growth in trades. This has been an important shift in the revenue mix, with corporate clients now representing over 40% of revenue. The broker believes the market has given up on the company's three-year strategy to double revenues but Ozforex is one third of the way through an investment phase which should set it up to grow strongly.

Shaw and Partners, not one of the eight brokers monitored daily on the FNArena database, retains a Buy rating but lowers its target to $2.40 from $2.70. While Western Union walked away after a request for further due diligence was rejected, another takeover bid cannot be ruled out, the broker adds.

Earnings were 13% below Deutsche Bank's estimates. The result and guidance downgrade do not overly concern the broker, as sentiment is very weak and there is valuation support as well as easier comparable periods to be passed. The broker also believes the cyclical headwinds experienced in the first half, driven by the depreciation of the British pound, are short term.

One of the reasons the broker remains positive is because part of the weakness in the first half was attributable to a low-volatility FX environment for the company's key pair AUD/USD. Deutsche Bank does not believe this constitutes a structural problem and retains a Buy rating, reducing its target to $1.70 from $2.20.

Macquarie does not believe the company's business model is broken but expects a lot of work will need to be done to get it back on track. Execution and earnings risk are high, although the broker notes the current valuation since the sell-off already appears to be discounting the prospect of achieving anything like revised FY17 guidance.

This would then provide an improved run rate in the second half going into FY18. Moreover, the international payments market is still relatively immature and one where scale and synergy benefits can be realised as consolidation continues.

Macquarie will look for an acceleration in North America into FY18, given the step-up in marketing that is expected following the re-branding and changes to the customer pathway. The company will continue to roll out its brand in North America and the UK in the second half. Existing brand recognition in these markets is lower and new websites should benefit from the history already established in the Australian domain, the broker believes.

The broker believes the company's active and lapsed client base, technology, licences and banking relationships should make the stock appealing to trade and financial buyers well above current levels. Hence, Macquarie upgrades to Outperform from Neutral but lowers its target to $1.80 from $2.30.

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article 3 months old

Profitability Peaking For Medibank Private?

While health insurer Medibank Private has flagged initiatives to improve customer experience, brokers suspect profitability is at the peak of the cycle.

-Could quickly become a single-digit growth stock when cost reductions end
-Management cautious about investing to change negative experience and leakage
-Stock considered reasonable value but lacking positive catalysts


By Eva Brocklehurst

Health insurer Medibank Private ((MPL)) has guided to FY17 health insurance operating profit for the first time, suggesting that this will be broadly in line with FY16. Brokers calculate this equates to around $490m. Meanwhile, growth in premium revenue for the first four months of the year has been below expectations, at just 1.3%.

Management has acknowledged top line growth is slowing and inroads are being made to its market share, outlining a number of initiatives to improve customer experience, to take effect in the December quarter.

Morgans believes the company was coy at the AGM about trends in claims but concedes this is a difficult area on which to obtain consensus. At the very least, recent industry commentary suggests claims utilisation is neutral to positive. This provides some confidence in the company's operating profit guidance. While further cost reductions and continued low claims utilisation may provide a near-term tailwind, Morgans envisages current industry profitability as a peak in the cycle.

The broker remains of the view that if Medibank Private cannot restore top-line growth in the first half, it could quickly become a mid single-digit growth stock when its cost reduction program ends. In that scenario, the broker believes the current price/earnings multiple for FY17 forecasts of 16.5x may be hard to justify.

Morgans acknowledges upside risks to its view on the stock could come from management being able to deliver more on cost reductions than it currently expects, or by reversing market share losses.

Industry data supports Macquarie's long-term net margin assumptions of 6.5%, a key sensitivity for the stock. Macquarie's base case price target of $2.75 assumes a net margin of 6.5% from FY19 and beyond. This is slightly below the rate achieved by competitor BUPA. BUPA has now replaced Medibank Private as the largest fund by premium share.

Soft revenue trends are already reflected in UBS estimates. The broker reduces its assumptions for claims growth to capture the more optimistic health insurance operating profit. UBS observes AGM commentary was particularly cautious regarding the investment required to change negative policy-holder experiences and stem a leakage of customers.

Given this backdrop, the broker is not inclined to expect higher net margins in FY18, or adopt a more positive view on the stock, and retains a Neutral rating.

Ord Minnett assesses the company's guidance on insurance operating profit removes the downside to its forecasts. Industry conditions are expected to be similar in FY17 to those of the second half. The company has flagged significant benefits from new initiatives for its customers. In addition to its free dental checks for Medibank Extras customers, new initiatives include all hospital cover members having accident cover and all members now having unlimited emergency ambulance cover.

Ord Minnett remains cautious about the likely benefits from these initiatives, noting that at this stage, the company believes the cost impacts will be offset by other savings. All up, the broker believes, if Medibank Private's assumptions hold up, this should take away downside risk. Ord Minnett continues to find the stock attractive, noting there is no gearing and the claims trajectory appears under control.

In taking into account the operating profit guidance for FY17 and marking to market, Citi lowers its forecasts for earnings per share for FY17 by 5% and FY18, FY19 by 1%. The broker expects slowing premium growth to persist, and estimates the guidance implies a net margin of 7.8%. The margin should benefit from the benefits of savings from the payments integrity program and hospital re-contracting, but the broker expects this to be offset by some normalisation in hospital utilisation rates.

Citi believes the uncertainty around the extent of margin re-investment that the new CEO is willing to undertake has dissipated somewhat. The broker interprets the commentary to suggest Medibank Private does not intend to invest more of its margin in restoring its customer proposition. While the stock looks to be reasonable value, positive catalysts are lacking and Citi will look for further elaboration of the company's strategy at the investor briefing on November 30

Credit Suisse suspects earnings growth will be difficult to achieve. The company has implied a higher expense base, the broker notes, as it is hiring 20% more contact centre service staff by Christmas. With gross margins continuing to be elevated, the outlook for the 2017 price increases becomes more challenging, in the broker's view.

As peers have recently commented on price increases of 4-6% in the medium term, the lower end of this range is most likely, Credit Suisse suspects. The broker's focus is now on regulatory risk, which it believes may limit growth in earnings per share for an extended period of time.

There are two Buy ratings, five Hold and one Sell on the FNArena database. The consensus target is $2.67, suggesting 8.1% upside to the last share price. Targets range from $2.40 to $3.00. The dividend yield on FY17 and FY18 estimates is 4.6% and 4.7% respectively.

Disclosure: The reporter has shares in Medibank Private.

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article 3 months old

EclipX Outlook Shines Brightly

The outlook for leasing and vehicle finance business, EclipX, is promising and brokers consider its growth ambitions remain well supported.

-Growth drivers include new vehicle sales and increased availability of finance options
-Upside risks to funding costs in the medium to longer term
-Appears to be taking share from competitors


By Eva Brocklehurst

The outlook for leasing and vehicle finance business, EclipX ((ECX)), is promising, as brokers observe the company has a high percentage of recurring revenue and strong visibility on earnings. The company's FY16 results were compositionally solid and cost discipline was evident. A strong funding position is expected to support the company's growth ambitions, with upside risk to earnings estimates expected from winning new clients.

FY16 cash profit of $55.3m was up 14%, above the guidance range of up 8.5-10%. New business worth $932m was written, leading to assets under management or finance (AUMOF) of $2.04bn, up 15%. FY17 growth guidance for net profit is 18-21%. The company has also made a small bolt-on car rentals acquisition, Onyx, to boost its Right2Drive business.

Macquarie envisages two key growth drivers for the automotive finance sector, which augurs well for EclipX. These are continued growth in underlying new vehicle sales and the increasing number of financing options available on competitive terms.

This includes dealer finance at the point of sale, on-line offers, novated leases and fleet funding. The increased range of funding options is leading to a greater proportion of consumers using finance to purchase a vehicle and the broker notes this has risen to 49% in 2015 from 41% in 2011.

Macquarie believes the company's warehouse funding structure, in which around 80% of the funding is in the form of at least AA rated security, is well placed to withstand any ructions in credit markets and places it in a strong competitive position. Moreover, Eclipx is not reliant on securitisation markets to continue to write new business.

UBS suspects, while near term interest rates are likely to remain constrained, there is risk to the upside for funding costs in the medium to longer term. In terms of sensitivities, the broker estimates that each 25 basis points of change in funding costs impacts FY18 forecasts by circa 2%. That said, any step-change in funding costs can be mitigated by price increases and a switch to using a greater amount of P&A (principal & agency) funding.

With strong momentum in new business, the company is well placed to continue growing share in the mature fleet leasing market, in the broker's opinion, and a substantial contribution is expected from this segment. UBS estimates equipment finance and Right2Drive account for around 20% of group profit in FY17, but will contribute 40% of the uplift in earnings over FY17-FY20.

The cost/income ratio was higher than CLSA expected, with on-boarding costs and Right2Drive integration providing the drag. The broker assumes AUMOF to be 6-8% higher than previously forecast and the net operating income/AUMOF margin to be around 90 basis points above prior forecasts. These are offset by expectations for a higher cost/income ratio and the deferral of operational expenses. Hence, the broker reduces earnings per share forecasts by 5%.

Nevertheless, the results still confirm the stock as the broker's top pick in the vehicle leasing segment. CLSA, not one of the eight brokers monitored daily on the FNArena database, retains a Buy rating and $5.00 target.

Given such a competitive industry, Credit Suisse is impressed with the performance and believes the company has the momentum necessary to meet FY17 targets. Trading at a price/earnings ratio of 14.7x on FY17 estimates, the broker considers the stock inexpensive. EclipX also appears to be taking share from competitors while maintaining discipline, in particular in the key area of setting residual values.

The broker acknowledges competition has had some negative impacts, such as lower net operating income margins in Australian commercial segments, but the company is envisaged maintaining profit margins through operating leverage and managing its risk profile.

Citi is more cautious compared with the preceding brokers. The results were largely in line with its expectations and FY17 is expected to come out ahead of guidance. The broker also believes there are more acquisitions on the horizon.

Citi retains a balanced outlook, welcoming the company's LogBookMe and Australian Taxation Office-compliant offering, which are observed gaining traction with clients, as well as the opportunities for growth into adjacent areas as R2D gains scale in the accident repair car rental market. Countering this are the potential challenges from increased funding costs, and pressure on interest and revenue margins as EclipX grows into the large corporate and government sectors.

FNArena's database shows four Buy ratings and one Hold (Citi). The consensus target is $4.22, suggesting 14.1% upside to the last share price. Targets range from $4.00 to $4.50.

See also, EclipX Confident Of Technology Advantage on June 9 2016.

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article 3 months old

Earnings Risks Heightened For Macquarie Group

Brokers suspect Macquarie Group's earnings are peaking as the diversified financial business has increased the levels of asset sales in its first half.

-Realising gains on asset sales making sense to brokers as valuations become vulnerable to rising global rates
-Citi believes profits and share price will not hold up indefinitely
-UBS expects upside still exists from improvements in operating efficiency

By Eva Brocklehurst

Is Macquarie Group ((MQG)) becoming more conservative in its outlook? This is the question brokers are asking in the wake of the first half results. The results beat most estimates, driven by significant gains on asset sales, mainly from the disposal of the Macquarie Life business to Zurich Australia, as well as co-investment assets.

Macquarie Group posted first half FY17 cash earnings of $1.05 billion, slightly above recent guidance. Guidance for FY17 to be broadly in line with FY16 was retained. Ord Minnett expects the first half is one of several upcoming periods where the bank will run higher levels of asset realisations. Given the current valuations of real assets in which Macquarie is co-invested, and the vulnerability of valuations as interest rates rise globally, this strategy makes sense to the broker.

This could also mean the so-called “quality” in earnings appears to deteriorate as earnings are supported by a higher proportion of gains on asset realisations. The broker calculates the contribution to FY17 estimates from asset sales shifts to a 6.5% tailwind from a 6.5% headwind. The retention of flat year-on-year guidance also suggests a corresponding reduction in the contribution from underlying operations.

Ord Minnett attributes this to weakness in corporate and asset finance and a higher compensation ratio. Accordingly, the broker assumes a higher run rate of asset realisations to fill the gap left by the weak first half. Despite the term “lower quality” being applied to gains from asset recycling, Ord Minnett is not overly concerned, believing this is an inherent part of Macquarie Group's business model.

Macquarie has significant amounts of co-invested capital in assets that have unrealised embedded gains, as asset values have risen globally in the low rate environment. Nonetheless, the broker interprets this to mean that the earnings outlook will be more dependent on transactions, until such time that Macquarie can acquire new assets at cheaper valuations.

Citi observes the extent of revenue from asset sales is a classic signal of the end of the cycle and earnings at this juncture are probably as good as they will get. Profits and the share price may hold up for a while but the broker suspects this will not be indefinite and retains a Sell rating.

UBS considers Macquarie a leveraged play on market movements and activity, the potential for further reductions in tax rates and a lower Australian dollar and believes, at a time when earnings growth is increasingly difficult, the bank can still pull levers which are not available to most. The broker also expects material upside from improvements in operating efficiency and believes the market is not fully pricing in this upside, retaining a Buy rating.

While Macquarie has invested significantly over a number of years and has a relatively conservative balance sheet, management still envisages opportunities across its businesses where growth may be delivered. With that observation, UBS acknowledges there are signs that that Macquarie is becoming more cautious, unusual for an organisation which is particularly optimistic about the outlook.

During the first half Macquarie generated $855m in gains on sales, almost twice as high as any period since the financial crisis, and the broker agrees the group may have decided to harvest embedded gains on a number of investments it has made over the last few years.

Credit Suisse makes some compositional changes to its FY17 estimates and downgrades to Neutral from Outperform to reflect the fact the stock price is approaching the target and earnings growth is peaking. This broker also points to an historically high level of realised embedded gains in the first half but suspects this might be overstated, in that the first half included the life insurance business gain which does not sit in the principal investment portfolio.

Morgan Stanley also suggests underlying revenue trends were weaker and that earnings will peak this year. Still, the broker flags the prospect for upgrades in the second half and notes the diversified business mix, a strong balance sheet and 5.5% dividend yield underpin the stock. The dividend was up 19% to $1.90 and the pay-out ratio was 62%, which is at the bottom end of the target range of 60-80%.

The broker does not expect quite the same split as in prior years because the seasonality of the group has been reduced and the first half was boosted by gains on sale. Nevertheless, Morgan Stanley raises its FY17 dividend forecast by 10% to $4.40, which equates to a 71% pay-out ratio.

Deutsche Bank suggests the strong run in the share price over the last six months appears to have priced in the group's strengths and believes there is cause for concern with the prospect of rising global rates and removal of stimulus by central banks. The prospect of the US Federal Reserve raising rates at its December meeting is casting a shadow over equity market and, perhaps, the broker muses, over asset values generally.

ASX-listed utilities and infrastructure stocks have already sold off in anticipation, Deutsche Bank notes, and as the number one manager of these types of assets globally this could present headwinds for Macquarie's infrastructure and real asset portfolio. In this context the valuation appears only fair and the broker downgrades to Hold.

Morgans observes some softness in underlying revenue trends in certain divisions in the first half such as corporate and asset finance, where net operating income was down 3% from lower loan volumes. Also, in asset management, where the increase in base fees was less than 1% despite funds under management being 3% higher. Commodities and financial market net interest income was down 16% on lower commodities trading activity.

Additionally, the Macquarie securities business, which experienced a 3% decrease in profit to $18m on weaker Asian trading activity, continues to struggle in the broker's view. Morgans likes the stock longer term but believes it is now trading closer to fair value and agrees earnings risks are heightened, given an uncertain global macro backdrop.

There is one Buy rating on FNArena's database (UBS), five Hold and one Sell (Citi). The consensus target is $78.21, which signals 1.9% in downside to the last share price. This compares with $76.69 ahead of the results. Targets range from $75.00 (Morgan Stanley) to $85.00 (Credit Suisse). The dividend yield on FY17 and FY18 forecasts is 5.2% and 5.6% respectively.

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article 3 months old

Australian Banks: Reporting Season Preview

Earnings declines, rising bad debts, potential dividend cuts, potential capital raisings – it’s not shaping up as a great reporting season for the Big Banks.

- Margins under pressure
- Weak earnings expected
- Dividends at risk
- Capital raisings possibly ahead


By Greg Peel

Earnings Decline

In the wake of each CEO having faced a parliamentary grilling, the pressure is off Australia’s Big Four banks, for now. Calls for a Royal Commission have subsided as politicians’ limited attention spans move on to other matters. RBA monetary policy is presently on hold, although we await this week’s inflation data. So the banks will not be drawing further ire by not passing on full rate cuts.

We may nevertheless see the usual round of shock-horror when three of the Big Four release their full-year earnings results, as the billions are revealed. The reality is bank earnings have likely gone backwards this year. It’s no great surprise – corporate earnings do ebb and flow – but if bank earnings growth is indeed net negative, it would be the first time since the GFC.

National Bank ((NAB)) will report FY16 earnings on October 27, ANZ Bank ((ANZ)) on November 3 and Westpac ((WBC)) on November 7. Commonwealth Bank ((CBA)) will provide a first quarter FY17 update on November 9.

The key risk for this reporting season, Citi suggests, is a continued failure to meet consensus revenue estimates. CBA, which reported FY16 earnings in August, was expected to generate second half revenue growth of 6% but reported 4%, the broker notes. Bank of Queensland ((BOQ)), which reported earlier this month, reported 0.5% against 3% expectation. Citi expects this trend to continue.

Morgan Stanley agrees revenue growth prospects have moderated further as loan growth slows and margin pressures increase. Net interest margins have fallen due to pressures on both sides of the ledger. Despite all the brouhaha over the banks not passing on all of the last RBA cut, discounting wars for mortgages have ensured that in reality, it has indeed been passed on to those who shop around. Despite no one ever paying attention to depositors, competition amongst the banks for deposits has also been stiff.

At the same time, levels of bad and doubtful debts (BDD) have been growing after finally hitting a post GFC trough. At the banks’ first half reporting season in May, the market was shocked with the level of “single name” exposures to the likes of failed electronics retailers, foundering law firms and cash burning miners. The good news is a repeat performance is not expected in the second half.

But the bad news is the “pockets of weakness” also apparent among BDDs in the first half, such as New Zealand dairy and Australian mining state exposures, will likely remain an issue. More worryingly, analysts expect BDDs to have risen across the broader Australian economy – not alarmingly so, but risen nonetheless.

In the meantime, the banks have been spending capital on systems upgrades to try to catch up to the modern world.

So if we add up weaker revenue growth, lower net interest margins, increased BDD provisions and increased capex, we get lower earnings. Goldman Sachs is forecasting a 6% net earnings decline in FY16 among the three banks reporting.

Dividends and Capital

Lower earnings should translate into lower dividends. And in terms of quantum of dividend, this will be true. But banks pay dividends based on a payout ratio of earnings, unlike, say Telstra, which pays a fixed quantum. Thus the real risk is a cut to payout ratios.

Dividends paid in cash reduce capital. The banks currently need to increase capital. By how much is as yet uncertain.

The new Basel 4 capital requirements for large international banks – those deemed domestically systemically important banks (D-SIB) or “too big to fail” – are expected to be announced by year-end. APRA then intends to add an additional capital requirement to Australia’s big banks to account for the smaller economy and population Australia’s banks service compared to, say, the US and Europe. All we know to date is that APRA requires Australian bank capital positions to be “unquestionably strong”.

APRA will quantify “unquestionably strong” once the Basel 4 requirements are known. This will not likely happen until at least early next year. At that point it will become more clear whether or not the Big Four need to raise more capital. In the meantime, analysts do expect the banks to address the drain on capital through dividend payouts at the upcoming reporting season.

The banks' current payout ratios are historically high. They were able to creep up and up as the fallout from the GFC subsided and the damage in Australia proved not to be nearly as extensive as feared. Having taken on board enormous provisions against BDDs and also against general macro-economic risk, the banks were able to feed these unused provisions back into earnings and reward (and attract) shareholders with dividend increases.

Those days are over. The GFC provisions are gone and BDDs are rising again, earnings are under pressure and capital requirements are increasing. Something has to give.

ANZ already took the hit. Most analysts assumed the banks would not cut their dividend payouts but if anyone did it would be the smaller two, ANZ and NAB. ANZ did, NAB didn’t, and neither did Westpac, nor CBA at its full-year result.

Six months on consensus is for more dividend cut announcements.

The Citi analysts, who were half right six months ago in predicting the ANZ cut, believe NAB and Westpac will both cut this time around. Goldman Sachs expects NAB to cut by 10% and suggests Westpac’s payout ratio “does look high”. Credit Suisse notes consensus is for NAB to cut by 4 cents. Deutsche Bank acknowledges “elevated” ratios. UBS would not be surprised in a NAB cut, although suggests the bank may wait until after the new capital requirements are known next year. Morgan Stanley believes the risk of dividend cuts remain for all the majors bar ANZ.

Macquarie believes the banks can sustain and should maintain their dividends in the current low growth environment, other than NAB.

Macquarie believes the banks can continue to partially rely on dividend reinvestment plans (DRP) to support their capital positions, maintain dividends and distribute franking credits to optimise value for their shareholders. DRPs represent an incremental, back-door capital raising given new shares are issued in lieu of cash. The Macquarie analysts acknowledge not all agree with their view.

“We continue to see value in the banks sector,” they say, “and believe concerns around the sector’s dividend sustainability are overstated”. However there is a caveat. Macquarie believes dividends are “largely” sustainable “putting the potential for additional capital accumulation aside”. The analysts’ view is therefore dependent on as yet unknown Basel 4 and APRA quantification.

And this is The Great Unknown. It is a bit hard for bank analysts to make predictions and subsequent forecasts. However, Morgan Stanley has long assumed the banks will indeed be forced to raise more capital. The broker is forecasting a net required capital build for CBA, NAB and Westpac of around $16bn by FY18.

Morgan Stanley believes investors are largely dismissing the potential for a bear case outcome on capital requirements.

UBS is on the same page. The analysts believe the requirement for new capital is “likely to be substantial”, potentially exceeding the capital raisings undertaken by the banks last year. The regulators will give the banks a period of time to reach new capital benchmarks but the market, UBS suggests, “is unlikely to be as generous”.

With capital the focus, UBS suggests it is hard to build a compelling overweight case for the banks.

While assuming a weak FY16 overall, Goldman Sachs expects things to get better for the banks in FY17-18. Goldman is forecasting no further RBA rate cuts, which should lead to relief from margin pressure. The broker also expects increasing BDDs to be a mild rather than severe headwind, and thus expects earnings will stabilise.

On an average twelve month forward yield of around 6%, Goldman believes bank valuations are currently attractive. For the same reason, Macquarie also finds the banks attractive and remains Overweight the sector.

There are eight major brokers in the FNArena database covering the four Big Banks. As the table below indicates, collectively the brokers have twelve Buy ratings, eighteen Hold and only two Sell.

As for preference amongst the Four, the table is rather interesting. Westpac has held top preference for a while now, which is understandable given a leading 6% upside to consensus target price. Aside from a little bit of a blip last year, CBA is in the very familiar position of least preferred.

Typically CBA is least preferred due to investors perennially affording Australia’s biggest bank a premium over the other three, which is typically apparent in CBA showing either the least upside to target or even a target below the last treaded price. At present, CBA is second only to Westpac on upside.

CBA will provide its own update after the other three have all reported.

Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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article 3 months old

Growth Continues But Challenger Looking Stretched

Challenger Financial Services is benefitting from new distribution agreements and strong annuity sales. That said, several broker consider the valuation stretched.

-Uncertainty in margins and looming competition from banks clouds the outlook
-Favourable move in mix to longer-dated annuities
-Sales momentum impresses Citi but translation to earnings growth less clear


By Eva Brocklehurst

Growth has accelerated for Challenger Financial Services ((CGF)) as the business benefits from new distribution agreements and strong annuity sales in the September quarter. Importantly, brokers observe the sales mix continues to improve with longer duration and more profitable annuities.

Sales are strong across a variety of channels and Goldman Sachs believes this is the combination of annuities being included in more model portfolios, strategic marketing and a broadening of distribution partners. That said, the broker notes growth is capital intensive and Challenger has flagged plans to issue more tier 1 capital notes before the end of FY17. Goldman, not one of the eight monitored daily on the FNArena database, has a Neutral rating and $9.60 target.

Ord Minnett believes strongly in the company's ability to grow but remains concerned that the risks being taken to achieve targeted returns on equity are not being reflected in the share price. Annuity sales in the September quarter were $1.0bn, up 46%, and lifetime net book growth was 3.1%. The company has retained its normalised lifetime cash operating earnings guidance of $620-640m but the broker suspects this could prove conservative, given a more favourable outlook for cash rates and growth.

The growing distribution footprint is generating annuity sales growth and Bell Potter expects this momentum should continue, given new platform partnerships that are due to launch in the first half. This broker also believes the lifetime guidance is conservative and expects it may be upgraded at the upcoming AGM or the first half result in February.

Bell Potter has a positive view on the stock and expects catalysts for the company will come amid clarity from the federal government on the introduction of both Deferred Lifetime Annuities (DLAs) and Comprehensive Income Products for Retirement (CIPRs). Bell Potter, not one of the eight brokers monitored daily on the database, reiterates a Buy rating and has a $11.90 target.

Credit Suisse turns its attention to considering how much growth Challenger can fund. The broker estimates the company could theoretically fund $3.9bn, or 40% growth in its annuity book, before it would require an equity raising. This includes around 20% growth from utilising excess capital, 10% from retained earnings and 10% from hybrid availability. Credit Suisse expects high single-digit growth in earnings per share despite margin headwinds from lower interest rates, and believes the stock's current multiples are undemanding, considering the growth profile.

Challenger is the purest play on the under developed retirement income market but there is uncertainty in the margin outlook, which weighs on Morgan Stanley's view. The outlook for lifetime sales is uncertain and competition looms from the banking quarter in terms of annuities. The value drivers for the stock include the attractive yield opportunities and the risk/reward profiles of non-annuity products, as well as net flows from funds management.

Contributing factors to the lifetime annuities sales include allocations in model portfolios via the Colonial platform and greater traction from CarePlus following the product's re-launch. Morgan Stanley notes a 28.7% mix to longer-dated annuities compares favourably to 19.5% in the June quarter. The broker believes it is getting harder to deliver a 3.0% guaranteed return to customers, particularly with around 40% of the term book involving annuities under a year.

Morgan Stanley calculates bonus rates are probably sustaining the short-term roll-over rate in annuities at the expense of margins, while the shift in sales mix to longer duration and the planned FY17 capital raising are likely to insulate the downside risk. The broker retains an Equal-weight rating and considers the stock fairly valued. Morgan Stanley expects pension eligibility changes will remain supportive for Challenger's volumes and mix and help insulate margins.

Citi finds, while the sales momentum is impressive, the translation to earnings growth is less clear. Investment assets were up only slightly in the quarter and there is pressure on normalised capital growth and yield. The broker believes the stock has run too hard and downgrades to Sell from Neutral. Citi expected strong growth in lifetime annuity sales but the result was even stronger than its forecasts implied. Platform sales are now comprising 50% lifetime annuities with both Colonial and VicSuper contributing.

Tempering the impact on book growth was an elevated level of maturities but, even so, the quarterly outcome was reasonable, in Citi's view. The fact that Challenger only reiterated prior guidance suggests to the broker that strong sales are already incorporated in the numbers.

Morgans also downgrades, to Hold from Add, believing with the stock up 33% this year valuation metrics are becoming more stretched. The broker retains some caution in its outlook regarding the potential margin contraction implied by FY17 guidance.

FNArena's database has three Buy ratings, three Hold and two Sell. The consensus target is $9.83, suggesting 5.0% downside to the last share price. Targets range from $7.33 (Ord Minnett) to $11.50 (Credit Suisse).

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article 3 months old

BT Investment Solid But Caution Over Brexit Prevails

Brokers like the diversity in BT Investment Management but several remain cautious about the outlook, given lingering risks surrounding Brexit.

-Gains two more mandates to provide upside in the December quarter
-Australian business drives quarterly flows with upside from new global equities fund
-Cycling strong contribution from JO Hambro performance fees in FY16


By Eva Brocklehurst

BT Investment Management ((BTT)) surged to a new record in funds under management (FUM) in the September quarter, at $84bn. Brokers generally like the diversity inherent in the business, with strength in Australian fixed interest and US pooled funds and a global distribution footprint.

Yet while the stock offers a compelling global expansion theme and the flows suggest the risks from Brexit are lower than previously feared, Credit Suisse is cautious, citing the risks of a rotation in the US back to domestic US equities where BT Investment has a narrower product offering.

September funds under management grew 5.4% in the quarter. Growth was achieved through net inflows and positive market movements but offset by negative foreign exchange. The better than expected flows in JO Hambro and $2bn in mandate wins, mainly by JO Hambro, imply Brexit risks were over-compensated in its estimates, Credit Suisse acknowledges. Consequently, the broker upgrades estimates for earnings by 1% in FY16 and 7-9% in FY17-18.

Net inflows in the quarter were $2.2bn which resulted in an increase to annualised fee income of $4.5m. The business has gained two more mandates which are expected to provide fund upside in the December quarter. There is a $300m diversified income mandate in October and $1.7bn in JO Hambro equities to be funded in November. The latter is an institutional mandate which brokers note may lead to further flows.

Bell Potter considers BT Investment a top pick in the sector, with meaningful growth expected over the medium term. JO Hambro FUM is expected to double before capacity constraints are hit. Bell Potter also upgrades estimates on the better net flows and marking to markets, partly offset by the FX impact as well as adverse changes to FX assumptions in future periods.

Some risks remain in terms of Brexit, Britain's exit from the European Union, the broker agrees, particularly surrounding the trigger of Article 50 and resultant negotiations, which are currently expected to take place in March 2017. Nevertheless, Bell Potter is confident in the resilience of the JO Hambro business. The broker, not one of the eight monitored daily on the FNArena database, reiterates a Buy rating and raises its target to $13.

Australian business drove the flows in the quarter, led by institutional fixed income and cash. Morgan Stanley believes the company's growth options are broader than just JO Hambro, with upside in the medium term from the new Australian based global equities fund. The broker suspects the peak in outflows has passed and the US retail flow is proving strong, with JO Hambro having a strong product range for US retail.

While BT Investment is relatively reliant on a single client/distribution channel, i.e. Westpac ((WBC)), their interests are aligned, with Westpac owning 31% of the BTT stock, and it could provide further growth avenues in the broker's opinion. Upside potential exists with JO Hambro's expansion in the US and a sustained period of investment performance. The negatives include market volatility, which affects confidence and inflows, Australian equities margin pressure and pricing pressure from the UK retail competition review.

It was a firm final quarter, Morgans acknowledges, and the company continues to attract strong inflows across its core markets despite the uncertainty surrounding Brexit. The broker forecasts FY16 net profit of $145.9m and a final dividend of 22c (to be reported in November).

Areas of potential surprise are from product fees, investment returns and better than expected operational leverage. The business will cycle a strong contribution from JO Hambro performance fees, which at this point Morgans believes is tracking at a lower level. Further weakness in the British pound also creates a slight headwind in the broker's calculations.

FNArena's database has one Buy rating (Morgan Stanley), four Hold and one Sell (UBS, yet to update on the quarterly). The consensus target is $9.47, suggesting 5.0% downside to the last share price. This compares with $8.94 ahead of the update. Targets range from $7.30 (UBS) to $11.00 (Morgan Stanley). The dividend yield on FY16 and FY17 forecasts is 4.0% and 4.2% respectively.

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article 3 months old

Bank Of Queensland Yield Still Impressive

Bank of Queensland's results failed to impress brokers given margin pressure and subdued volumes, but the outlook has not deteriorated.

-Mortgage volumes expected to recover with reductions in discounting by peers
-Yet mortgage re-pricing could still be offset by ongoing competition and impact from lower rates
-Underlying cost growth guidance of 1% may be ambitious
-Strong dividend yield underpins stock and limits downside


By Eva Brocklehurst

Bank of Queensland ((BOQ)) produced a soft FY16 result, with cash earnings of $360m being lower than generally expected. Margin pressure and subdued volumes were the main reason the results failed to impress brokers.

With improved conditions recently experienced in mortgage and deposit pricing, Ord Minnett observes the weak margin did not reflect these new dynamics. While the margin re-basing in the second half is significant, with a seven basis points decline to 1.90%, the outlook is now considered clearer.

Rules regarding the net stable funding ratio (NSFR) have been clarified and this eases the pressure on the bank to gather deposits, and when combined with lower front-book discounts on mortgages, should, in the broker's view, provide for significantly fewer margin headwinds in FY17.

Meanwhile, mortgage volumes are expected to recover with a reduction in front-book discounting by peers, and the ongoing growth in Bank of Queensland's specialist book as well as the new Virgin-branded product. Hence, Ord Minnett believes the bank is well positioned to return to growth in FY17.

The broker regards the stock as fair value and, while finding better value elsewhere under coverage, rates it a Hold along with National Australia Bank ((NAB)) and Westpac ((WBC)).

Macquarie believes the stock may look relatively inexpensive, particularly versus Bendigo & Adelaide ((BEN)), but there is better value to be had in the major banks. The key disappointment was the net interest margin, partly, as the broker observes, because of the bank's desire to strengthen its funding mix ahead of regulatory changes.

Macquarie suspects the benefits of mortgage re-pricing are likely to be offset by ongoing competition and the impact of lower interest rates. In isolation, the revenue trends suggest the earnings backdrop is challenging in FY17 and the broker is pleased the bank is cognisant of the need to manage costs.

That said, underlying cost guidance for growth of just 1% is considered ambitious, particularly in the light of the expected rise in amortisation expense and cost growth from the Virgin product. Macquarie calculates the bank will need to achieve a 5% reduction in expenses from productivity benefits to achieve its guidance.

While struggling to reconcile the extent of the underperformance on interest margins in the second half, Goldman Sachs concludes that the pressure should subside. In its view, the bank should be able to partly offset the pressure from a flat outlook for non-interest income via cost reductions, and there is nothing to suggest a material deterioration in asset quality is likely in the near term.

Goldman no longer forecasts earnings-per-share growth into FY17 but suspects share price downside could be limited, given the strong dividend yield and a relatively undemanding FY17 price/earnings ratio of 12.2x. Goldman Sachs, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Neutral rating with a $11.59 target.

Citi does not believe the soft revenue outcome in FY17 is the whole story, with second half revenue growth of 1% actually slightly ahead of other banks which have recently reported. The broker believes, instead, that Bank of Queensland was caught up in a late cycle investment in its mortgage distribution capability, launching these products into an ultra-competitive market.

The broker also accepts net interest margin pressures should ease as, with very little recent front book growth, more of the recent back book re-pricing will hit the bottom line. Moreover, despite the missteps in FY16, the challenges faced in FY17 are not unique to Bank of Queensland. Citi notes the bank remains differentiated from its peers by its strong capital position and high dividend yield.

Credit Suisse downgrades its estimates by 8-10% following the result. The broker liked the cost discipline emerging and improved asset quality metrics but did not like the soft margins and contraction in the mortgage portfolio. The broker suspects the key risks are to the downside in terms of net interest margins and an adverse turn in the credit cycle.

Mortgage re-pricing failing to offset funding costs and asset competition highlights the fragility of the bank's funding profile, which Deutsche Bank attributes to an inability to raise deposits without offering interest rates that are much higher than peers. While the ability to improve deposits will take time the broker believes, with uncertain margins and asset growth, the stock's valuation is fair and deserving of a Hold rating.

FNArena's database has two Buy and five Hold ratings for Bank of Queensland. The consensus target is $11.64, suggesting 5.4% upside to the last share price. This compares with $12.00 ahead of the results. Targets range from $10.50 (UBS, yet to update on the results) to $13.75 (Citi). The dividend yield on FY17 and FY18 is 7.0% and 7.1% respectively.

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