Tag Archives: Transport

article 3 months old

Weekly Broker Wrap: Financial Inquiry, Transport, Fox And Salary Packaging

-NAB best placed after inquiry
-Upside for AIO and TOL
-What will replace FOX?
-Strong growth for MMS and SGF
 

By Eva Brocklehurst

The battle lines have been drawn in Australia's Banks And Financial Services Financial Systems Inquiry. Common themes found by Credit Suisse in submissions include tax reform, promotion of appropriate competitive neutrality and removal of regulatory overlap. The most contentious areas, in the broker's view, are related to new digital payment providers encroaching on major banks, funding of the Financial Claims Scheme - ex-ante opposed by the banks, the conservatism of the Australian Prudential Regulation Authority, mortgage risk weightings, regional banks seek a lower ceiling - and government intervention to promote a larger domestic corporate bond market, which Treasury opposes but many favour.

The interim report is expected by September and the final by November. Credit Suisse expects, over time, that the major's balance sheets will improve in terms of lending diversity and composition. The broker considers the likely winner from the inquiry will be National Australia Bank ((NAB)) with the bigger mortgage players, Commonwealth Bank ((CBA)) and Westpac ((WBC)), relative losers.

BA-Merrill Lynch thinks there's enough evidence the Australian economy is improving. Port volumes are up, a key indicator of activity given the flow on to rail and transport. Hence, the broker is warming to Asciano ((AIO)) and Toll Holdings ((TOL)). Nevertheless, just as cyclical risks look like easing there is evidence that structural risks are rising. The broker observes Asciano is facing disruptive price competition in terminals and Pacific National (PN) Rail and there are concerns around the take-or-pay contracts at PN Coal. Merrills thinks PN Coal's issues are manageable but suspects the others could entail downgrades to FY15 expectations.

Toll faces risks from the resources slowdown, and margin pressure from labour inflation as well as contract roll overs from the Singapore government. Both stocks are trading at 12-month lows so Merrills thinks there's opportunity for investors that are comfortable with the risks to wait for better activity levels to come through. Brambles ((BXB)) remains the broker's top pick in the sector based on a view the company is starting an earnings upgrade cycle because of its leverage to an improving US economy. 

21st Century Fox ((FOX)) will be removed from the Official List of ASX on May 8. Morgan Stanley has looked at what might take the stock's spot in the S&P/ASX indices. In the broker's order of highest probability IOOF ((IFL)) is the number one pick for the S&P/ASX 100 with Transpacific Industries ((TPI)) and Australand ((ALZ)) second and third respectively. In the S&P/ASX 50 it's Ramsay Health Care ((RHC)) and SEEK ((SEK)) in that order. In the S&P/ASX 200 the number one replacement pick is Sundance Energy ((SEA)) and number two is Steadfast ((SDF)).

Salary packaging, including novated leasing, and fleet management form part of a sector that is set to grow, in Macquarie's view. Salary packaging administration involves payment of pre-tax salary to a trust where money is then disbursed to cover employee's costs such as leases, superannuation, mortgages, school fees, entertainment accounts and so forth. Novated leasing is the largest part of salary packaging. It involves a three-way deal between a financier, employer and employee and these leases are sold to the corporate and government sectors. The novated lease market now accounts for an estimated 20% of the funded vehicle market. The growth drivers for the sector are employment, particularly in health and education, growth in new vehicle sales and outsourcing of fleet management. The broker also believes there are new product opportunities to help grow the market. Within fleet management there are products designed to improve driver safety and alertness and within the salary packaging there are opportunities to sell other services across an employer's employee base, such as credit cards.

Macquarie observes the two ASX-listed companies in this area have produced solid revenue and earnings growth and both generate high returns on equity of 25-30%. McMillan Shakespeare ((MMS)) has the longest listing history in the sector and is the largest player. Macquarie expects MMS to resume its long-term growth trend in FY15, after the interruption from the former government's proposed FBT changes last year. The broker thinks the acquisition of CLM in the UK last year represents a long-term growth opportunity. Newly listed SG Fleet ((SGF)), is the third largest in the sector and derives 37% of its FY13 revenue from novated leasing.

Goldman Sachs has initiated coverage of SG Fleet with a Buy rating and expects the stock to re-rate as it achieves FY14/15 prospectus forecasts. This broker sees growth opportunities too, as several large public authorities still manage fleets in-house and may look to outsource. The sector has high returns and as SG Fleet derives only 43% of its earnings from novated leasing versus McMillan Shakespeare's 60%, Goldman considers SG Fleet has less regulatory risk. Goldman has a Neutral rating on McMillan Shakespeare. Given the recent action by the federal government in ceasing subsidies to automotive manufacturer's the price/earnings discount applied to novated lease earnings has been raised to 40% from 20%. The broker's multiple on salary packaging earnings is now a 20% discount compared with a 10% premium versus the Small Industrials Index. Goldman's recent discussions with industry contacts have signalled salary packaging is sometimes priced at lower margins to win more lucrative novated lease work.
 

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article 3 months old

Weekly Broker Wrap: Exports, Jobs, Transport, Bank Credit And Retail

-Export boom on the way?
-SMEs still critical to jobs growth
-Subdued growth weighs on transport
-Baby boomers affecting bank credit
-Durable goods retailer prospects better
 

By Eva Brocklehurst

What is the prognosis for Australia's economy? Will it manage to revive without relying on mining investment? These are the questions economists at Citi are asking. It's not just whether demand outside of mining will generate enough investment to offset mining's decline but whether the timing of the transition can be coordinated as well. If not, there's a substantial amount of volatility ahead.

Can the fall in mining capex and loss of income from a deterioration in the terms of trade be offset by enough strength in housing construction, non-mining business investment, consumer spending and net exports? Citi calculates that major project capex across coal, iron ore and gas is likely to halve which implies a fall in mining investment by 2018 of around 4% of GDP from the peak of 7.6% of GDP in FY13. Timing is uncertain, but Citi analysts suggest the fall could be most marked after FY15, as LNG projects are set to hold up the level of capex this year.  Unlike investment booms in other areas, the analysts note the mining boom produces a ramp-up in exports as the production phase gets underway. The Bureau of Resource and Energy Economics is the benchmark for exports forecasts and its data suggests that mining and energy exports will increase the contribution to GDP through to FY18, the bulk of the increase being in the next two to three years.

The cumulative drag on real GDP from mining investment is likely to be at the bureau's largest in the next two years. So, with declining investment broadly matched by a positive contribution from net exports, the real pace of growth is likely to be determined by non-mining domestic activity. Thanks to stimulatory monetary policy, Citi thinks there will be a sufficiently robust rally in housing and consumer spending to achieve growth close to trend in 2014-2016 and possibly enable growth to strengthen even more in later years, with the help of recovery in non-mining business investment and a lift in spending on infrastructure. Citi acknowledges this number crunching looks suspiciously stable, with GDP forecasts close to trend, but emphasises that growth is more stable already, in terms of the trade downturn, compared with previous cycles, because of better policy and institutional reforms. All in all, an investment boom being replaced by an export boom means that domestic demand does not need to do all the heavy lifting in rebalancing the economy.

Where will the jobs come from? That's what UBS asks. The analysts looked at the sectors of the economy which have created the recent improvement in the job market. Around 80% are in public-dominated sectors, with some gains in manufacturing, construction, finance and real estate which were countered by weakness in retail, accommodation and food. Most of the private sector jobs over the same period came from mining related areas, reflecting strength in professional, technical and scientific jobs. From analysis of the labour hire and job advertisement data, the broker identifies an ongoing reality that the majority of jobs are in small and medium-sized enterprises and this is where the growth is likely to come from. It's not from large business, where there tends to be highly publicised job losses that mislead in terms of the proportion of jobs being churned in the economy.

The public sector is not expected to contribute such a level of job improvement in the near term but a lower Australian dollar should benefit those sectors such as tourism education and domestic manufacturing, according to UBS. Manufacturing performance has already recovered a little and tourist arrivals have risen 8-9% over the past year. Relatively labour-intensive and interest-rate sensitive sectors of the economy - retail, wholesale trade and construction - are also likely to reveal a jobs recovery. The key sectors which could, in the current environment, plausibly contribute jobs include retail, wholesale trading, accommodation and food, construction and general services. Those most likely to be shedding jobs include manufacturing, mining and related areas.

Goldman Sachs has recently revised Australian dollar forecasts and incorporated this into assumptions about the transport sector. Factoring in a lower Australian dollar has meant downgrades for airlines - Qantas ((QAN)) and Virgin Australia ((VAH)) - and upgrades for US dollar reporting stocks such as Brambles (((BXB)) and Recall ((REC)). This is also broadly neutral for Asciano ((AIO)), Aurizon ((AZJ)) and Toll Holdings ((TOL)), which are more exposed to Asian currency movements. Domestic economic growth is expected to stay relatively subdued over the next 12 months. The analysts believe the non-mining economy will need to accelerate to 3.75% by the end of the year just to meet a 2.0% GDP growth forecast, given the drag from mining investment. This weak outlook is expected to weigh on volume in the domestic transport sector, particularly for Asciano and Toll. Asciano remains the broker's preferred pick for the sector. A transition to positive free cash flow in FY15 and progress on cost of capital should help drive a re-rating, in Goldman's view.

BA-Merrill Lynch observes the demographic that supported the growth of bank balance sheets for the 20 years to 2010 is fading. Unless banks can convince retirees to dramatically increase debt levels the broker thinks household credit will struggle to grow at anything beyond nominal GDP on a sustainable basis. Smaller consumer loan books suggest ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) are best placed to confront this structural challenge, although near-term business credit growth also appears cyclically weak.

The broker emphasises this is not the end of the housing rebound, rather that medium term growth will be slower and historical rates unlikely to be repeated. The broker also views the rise of investors in housing as a natural response to demographic change, although this contributed to a substantial rise in household gearing. As the pre-retirement 45-64 age group increased so did investor housing and overall debt. Now this demographic is approaching retirement and recent data suggests the 55-plus group reduced gearing from 2010-12. While Westpac's ((WBC)) greater investor mortgage exposure offers some appeal near term, Merrills thinks it is unlikely to offer substantial upside relative to peers.

Retailers have had mixed fortunes recently, with several finding it hard to balance top line growth with margin preservation. Either way, Merrills thinks the household/durable goods retailers have better growth prospects than department stores and apparel merchants. Why does the broker like the former? First there's industry consolidation. In the last three years store numbers outside of the three majors - JB Hi-Fi ((JBH)), Dick Smith Holdings ((DSH)) and Harvey Norman ((HVN)) have declined by 33% which provides a more favourable market dynamic for the majors. The broker also believes household goods face less competition from online than soft goods and the penetration of online sales will begin to plateau at levels below other developed countries. The level of store saturation in Australia in consumer electronics and appliances is behind global peers and this supports continued store roll out, to some extent, Merrills adds. The preferred stock is JB Hi-Fi , which the broker thinks has the ability to grow earnings by over 35% in the next three years, self-fund capex and maintain a dividend pay-out ratio of 60-65%.
 

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article 3 months old

Automotive Holdings Lifts The Bar On Scale And Diversity

-Strong long-term earnings potential
-Strategically sound deals
-Higher margins, improved logistics likely
 

By Eva Brocklehurst

Automotive Holdings ((AHE)) has made two substantial acquisitions with a strong rationale to increase scale and diversity. Hence, the deals have been welcomed by brokers. The company will acquire Sydney-based Scott's Refrigerated Freightways for $116m and Bradstreet Motor Group for $68m, funded by debt and an equity placement of $115m. Management has also confirmed approaches by prospective buyers for the Cov retail stores in Western Australia but discussions are preliminary. Morgan Stanley observes such a sale would be well received by the market as it would divest a non-core business.

Both the new businesses have higher operating margins than existing AHE operations, with Scott's providing increased flexibility in road transport. Scott's will take over the remainder of JAT Refrigerated Road Services it doesn't own to incorporate that into the acquisition. Scott's will provide a truly national cold storage business and AHE will become the largest cold transport and storage provider in Australia. Bradstreet will provide 13 automotive dealerships in NSW, countering the overweight representation of Western Australia. After the acquisitions AHE will have net debt of 17.1% of assets and around $70m in undrawn facilities. 

Morgan Stanley thinks Scott's will add network scale and long-term earnings growth. AHE has identified $4m in synergies from cold storage, supplier terms and other savings. This provides a strong cornerstone in cold chain logistics with scope to grow, the broker contends. Morgan Stanley expects the combined logistics division to reach $1bn in revenue in FY15. This would warrant a significant premium to AHE's trading multiple if the company can execute the strategy well. The Bradstreet dealership increases the company's share of favoured brands and also provides a new market in Newcastle. Morgan Stanley believes AHE is a compelling investment and has upgraded to Overweight with a target of $4.50, expecting earnings growth of above 20% from FY15. The company's market share is expected to rise to over 10% of the automotive retail market in the medium term, from around 5% currently.

BA-Merrill Lynch likes the Bradstreet deal, as AHE continues to consolidate a fragmented market and drive scale benefits. There is significant further opportunity for margin expansion and the broker believes the industry is less cyclical than the market fears. This is a straight forward acquisition. Merrills is less impressed with the Scott's acquisition, given disappointments in the past with the Harris acquisition, but acknowledges the scale benefits of a larger network. Management alluded to trading continuing in line with expectations. This reassures Merrills, given the soft car sales numbers from some quarters. The broker expects the combined acquisitions will be 12% earnings accretive from FY15.

The deals make strategic sense to CIMB. The broker is conscious that the Scott's deal increases the company's exposure to the underperforming cold storage and transport business. Nevertheless, there is potential for increased efficiencies. CIMB's analysis suggests the Bradstreet acquisition adds the same accretion to earnings per share as does Scott's, despite being almost half the price. Scott's higher skew to road transport compared with AHE's existing business means there's less subcontracting and the diversity of customers and freight types reduces seasonality and exposure to climatic events. All these are positives in CIMB's view. The broker has run a bull case scenario to incorporate the targeted synergies into FY15 forecasts. This implies FY15 earnings accretion of 11.5% and on that basis AHE would be trading at 10.1 times FY15 price/earnings. CIMB has not incorporated the acquisitions into forecasts but, if so, this would increase the valuation to $5.11. The broker retains a $4.66 target.

UBS notes both acquisitions are yet to be finalised but, also taking the opportunity to reflect the impact on estimates, expects FY15-16 earnings will be lifted by 10.7-14.8%. UBS expects higher margins will be derived from the increased scale in transport and cold storage and this should improve returns for AHE's logistics division. The expansion in automotive dealerships reflects the company's long-term strategy of diversification in order to provide a more stable earnings platform. In FY13 Bradstreet generated $449m in revenue with an earnings margin of 3.5%.

It's all positive from a strategic and financial aspect, according to Deutsche Bank. The multiples paid are also reasonable and the broker thinks the Scott's acquisition could be the catalyst for improving the company's underperforming logistics business. The broker lauds AHE's record in obtaining value upside from automotive acquisitions as the industry is well suited for consolidation.

As for the logistics business, the experience has been less than impressive, Deutsche Bank concedes, but not altogether poor. Since the acquisition of Harris in 2011 and the loss-making Toll Holdings ((TOL)) assets in 2012, cold logistics have increased earnings by 50% but incremental earnings generated returns on invested capital of just 10%. Far from attractive, Deutsche Bank observes. In AHE's defence, the company has pursued a strategy of expanding and upgrading facilities across the country and this is only partially complete. Deutsche Bank believes the benefits from Harris and Toll and potential benefits from Scott's will take time to realise but will be enhanced by the network breadth offered by Scott's.

On FNArena's database the stock has five Buy ratings and two Hold. The consensus target is $4.36, suggesting 15.7% upside to the last share price. On FY14 forecasts the dividend yield is 5.7%. On FY15 it's 6.3%.
 

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article 3 months old

Treasure Chest: Toll Weighed Down By Slow Growth

-Headwinds to global business
-Manufacturing decline weighs
 

By Eva Brocklehurst

Freight heavyweight Toll Holdings ((TOL)) is in a strong position vis-a-vis the expected improvement in the domestic economy. The more activity, the more the company transports. Toll has also been busy reducing costs in its global freight forwarding business and now drives a lean machine. So why have several brokers voiced concerns about the business, particularly on the global forwarding front?

CIMB Securities is hesitant to recommend the stock. The broker has a Reduce rating and $5.26 price target. CIMB thinks there are enough risks to the outlook to be cautious regarding 2014. A low-growth environment means subdued activity and this should belie any cost cutting efforts. That said, the broker does expect free cash flow to improve and this should deliver a higher dividend. Pressures are coming from competition in global freight forwarding and less activity in the resources industry. To become more confident, the broker would need to see increased consumer activity in the domestic economy. Why is this so important? The company takes 80% of earnings from domestic operations so the economy is a key driver of the outlook. What's positive is that Christmas retail trading was solid and this would have benefited the company. Housing and consumer spending should also remain supportive.

So, where is the niggle? The logistics operating environment has become competitive and CIMB's checks have revealed that many contracts, rather than being rolled over, are being put out to tender on expiry. This puts downward pressure on pricing and margins, as operators face lower top line growth but still experience increased costs. As this trend is likely to continue in 2014 CIMB thinks much will depend on what sort of volume recovery is seen in the broader economy.

JP Morgan recently reviewed the stock and echoed some of these concerns, downgrading to Underweight from Overweight in one fell swoop. The broker expects a flat first half on a constant currency basis and, while the depreciation in the Australian dollar is expected to help, the market may be more keen to focus on the underlying trends. In this aspect, JP Morgan observes Australia's GDP has almost halved since the peak in growth at the beginning of 2012. As manufacturing output closely follows GDP - and is an important indicator for a transport business - it implies weakness for Toll. Another number the broker quotes is container volumes at the main ports. For the five months to November these were up 0.4%, with Melbourne and Sydney each down 2.6% - not a good look.

Essentially, the broker fears disappointment and has recommended taking profits in the lead up to the results. JP Morgan expects domestic divisions to perform relatively well and thinks the main issues are with global forwarding. Moreover, the market may like to see action on the disposal of underperforming business and as this has been slow to materialise the broker is hoping for an update on targets and strategy.

CIMB thinks global freight forwarding will be a continued drag on earnings and, while management has been trying to position the business appropriately, it remains sub scale. In the interim results, due on February 19, CIMB will be looking for the cost cutting benefit from the first half and whether margins have withstood the mounting pressure. Also cash conversion was weak in the prior corresponding half and the broker will be wanting see if the company has addressed the issues on that front.

Those in the more neutral camp, albeit without recent updates on the stock, such as Citi, UBS and Credit Suisse, also think there's mounting challenges. Citi expects volumes to recover but considers this is factored into the share price already. UBS has been concerned about gradual margin declines in Toll's parcel express division while Credit Suisse thinks global forwarding is running into headwinds but likes the attractive cash flow. Deutsche Bank is the one broker on the database that retains a Buy rating.

The stock has four Sell ratings, three Hold and one Buy on the FNArena database. The price targets range from $5.00 to $6.10 (Deutsche Bank). The consensus target is $5.45, which suggests 3.5% downside to the last share price. Toll has a consensus dividend yield of 5.0% for FY14 on the database and 5.3% for FY15.
 

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article 3 months old

The McAleese Compulsion

- Broker initiations
- Transport and logistics solutions in the right sectors
- Compelling valuation


By Greg Peel

McAleese Ltd ((MCS)) provides specialised transport and logistics solutions to the infrastructure and resource sectors.

An investor looking to find upside opportunity at the smaller end of the market capitalisation scale, given a call from many an analyst that large caps are looking well-priced, would be forgiven for feeling any exposure to Australian infrastructure and resources is a one-way ticket on the train heading out of town. The Australian economy is transitioning, we were told at length in 2013, away from “mining” and back towards those non-mining sectors which have either been quiet since the GFC or heavily impacted in recent years by the strong currency. It is easy to fall into the trap, nevertheless, of misconstruing what throwaway lines like “the end of the mining boom” actually mean.

Notwithstanding an LNG export industry still very much in the ramp-up phase, Australia’s China-driven mining “boom” has not actually “ended”. It has simply shifted from its ramp-up phase into its production phase. During ramp-up, mining companies spent billions increasing their production and processing capacity in order to exploit demand from China and other emerging economies anticipated to remain in at least a gradual uptrend over subsequent decades. With a few exceptions, such as the two big iron ore miners’ ongoing Pilbara expansion plans, Australia is now “ramped up”. This means less engineering and construction requirement in the sector – a fact already evident given the recent routing among listed engineering and construction contractors. The projects are complete. Let the production begin.

So once produced, how do Australia’s mining products then make their way into the hands of buyers? They are transported in most cases by sea from Australia’s ports. Getting to those ports requires a good deal of transport and logistical solutions.

McAleese’ key activities include specialised transport and lifting, bulk haulage and metropolitan liquid fuels distribution. The McAleese strategy is to make accretive acquisitions and build a diversified Australian transport and logistics company. As an example of its activities, a month ago McAleese won an additional contract with iron ore miner Atlas Iron ((AGO)). Brokers agree that Atlas’ ambitious production growth plans provide the potential for the company to become a significant player in the sector, assuming stable iron ore prices, but that the company’s biggest issue is a lack of transport infrastructure. The new contract signs up McAleese to 3mtpa of iron ore loading and haulage over four years, which Deutsche bank notes is worth some $60-70m for MCS.

“In our view,” say the Macquarie analysts, “one of McAleese’ key strategies is to grow with existing customers such as Atlas Iron. From a standing start in FY09, Atlas is targeting a 15mtpa run-rate by FY15. McAleese has an umbrella contract with Atlas”.

“Despite concerns around the outlook for mining and infrastructure capital expenditure in Australia,” the Macquarie analysts go on to suggest, “we are reasonably confident in the longer term revenue outlook for the specialised transport and heavy business given its specialist skills and integrated service offering”. The company’s existing contracted revenue base sourced from its oil & gas business provides a “stable backbone” given the mature nature of the industry. And the group’s strategy is to continue to build a leading diversified transport and logistics company by expanding into new segments, geographies and product capabilities.

Macquarie initiated coverage on McAleese just before Christmas, with an Outperform rating. Credit Suisse initiated coverage this morning, also with an Outperform rating. Deutsche Bank retains a Buy rating, bringing to three the number of FNArena database brokers now covering the stock.

Credit Suisse is not oblivious to the risks perceived for a contractor in today’s Australian resource sector. To account for such risks, the analysts have built expectations of a decline in the mining/energy capex outlook into their valuation model, amounting to a 41% reduction in sector earnings before interest and tax for MCS over FY13-16. They have also conservatively factored in the assumption of a potential loss of existing fuel distribution contracts with BP and Shell, to the tune of 50%.

Credit Suisse still finds MCS offers a “compelling” valuation.

According to the analysts’ numbers, MCS is trading on an FY14 price/earnings multiple of 10x which represents a 30% discount to transport peers and a 36% discount to the Small Industrials. MCS generates a greater return of equity than its peer group (14.1% to 11.2% average) and exhibits lower gearing. Credit Suisse forecasts a 10% compound annual growth rate in earnings per share over the next two years and believes the stock’s price/earnings multiple will re-rate over the next 12 months as management executes on its acquisition/contract win strategy and de-risking is achieved through existing contract renewals.

Macquarie has lined up the usual suspects among the listed transport & logistics sectors to offer a benchmark comparison for MCS – Toll Holdings, Asciano, K&S Corp and Boom Logistics. The analysts have further widened their benchmarking by looking at mid-cap mining service companies as a comparison. Based on earnings multiples among comparables, Macquarie has arrived at a valuation for MCS which forecasts a 15.9% return on equity and a target price of $1.88 (last trade $1.54).

Credit Suisse has set its target at $1.80 and Deutsche Bank $1.75 to provide an FNArena consensus target of $1.81. Consensus shows a dividend forecast of 4.2cps in FY14, rising to 7.0cps in FY15 and beyond.
 

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article 3 months old

Domestic Dogfight: Qantas Vergin’ On Desparation

-Capacity oversupply to persist
-Virgin's cashed up and ready
-Qantas market share a casualty
 

By Eva Brocklehurst

There's a battle looming in the skies above Australia and it's about grabbing market share. Virgin Australia ((VAH)) and Tigerair are adding capacity while Qantas ((QAN)), as yet, has shown restraint. Something has to give. Either Qantas relinquishes domestic market share - which the airline aims to maintain at 65% - or makes a response to the other carriers.

Macquarie thinks the softness in the domestic economy is taking a toll on Qantas. The economy is just not growing enough to absorb the excess airline capacity. There are not enough top paying passengers. Regional yields are being affected by increased competition from Virgin, while sluggish demand and corporate pricing pressure is squeezing yield at the top end in Qantas' international operations. Macquarie notes Virgin is looking to add 7% capacity growth to the market and Qantas is probably going to have to step up capacity to meet this. JP Morgan has analysed the current domestic airline seat capacity as well as demand. Market oversupply is calculated at around 2% of capacity. The broker has a negative view on the sector and thinks Qantas is not out of the woods yet, in terms of resuming profit growth.

In FY13 domestic airline market seat capacity is estimated to have increased 8.2% at the same time demand growth increased 5.4% - that's the comparison. JP Morgan estimates, if no additional capacity is added to this position as at September 2013 and demand increases 1.8-2.5% per annum, it would take a year to absorb the excess supply. Hence, the broker's forecasts for the airlines assumes the difficult conditions will persist. In the case of Qantas' 65% long-term market share aim, JP Morgan suspects that, on all metrics for the year ending September 2013, it has already slipped below that figure. The domestic share of seat capacity was 64.1%, the share of revenue per seat kilometres was 64.4% and the airline took 62.7% of passengers.

September load factors fell 2% across the Qantas group, according to Macquarie, and the trend has continued into October and November. The broker does not expect conditions to reverse any time soon. Importantly for investors, this deterioration was occurring prior to Virgin's equity raising earlier this month. Macquarie observes there's been negative yield growth at Qantas since July. Qantas has guided for a group-wide yield decline of 2-3% for the first half, more than what the broker expected.

Macquarie considers Qantas is yet to see benefits from cost improvements, efficiency gains, or the ongoing agreement with Emirates and has decided to downgrade the stock to Neutral. Deutsche Bank maintains that, as the second half is traditionally weaker, there's little likely that Qantas earnings will recover by enough to turn the business around any time soon.

The question brokers are asking is: how can Qantas respond to the competition? Macquarie notes Qantas has complained about the ongoing investment in Virgin by international airlines and, while a repealing of the Qantas Sale Act is unlikely, the solution may lie with a deepening of the partnership with Emirates.

Virgin Australia's recent capital raising provided the means to push for equality with Qantas in the domestic market. Macquarie does not think the company is trying to flood the market with capacity but is looking to add density on specific regional or under-serviced routes. It's just that passenger demand is simply not available to fill all seats in the market at current prices. The $350m rights issue boosted cash reserves and the four strategic shareholders took up their entitlements, which indicates ongoing corporate interest in UBS' opinion. Hence, Virgin's share price is likely to be underpinned by the major shareholders and the potential for privatisation.

Qantas, on the other hand, is expected to be a casualty of all this. Credit Suisse believes the coming 12 months will enable better judgment of the shape of the domestic market but, as Virgin is now competing in all market segments, the extent of any bleeding from Qantas will depend on Virgin's final cost advantage. CIMB responds thus: more funds for Virgin means more competitive pressure for Qantas. A situation that's here to stay and perhaps intensify.

Qantas has a range of recommendations. On the FNArena database there are three Buy, two Hold and two Sell. The consensus target price is $1.52, suggesting 32.2% upside to the last share price. Virgin Australia has one Buy, four Hold and three Sell. The consensus target price is 40c, suggesting 2.9% upside to the last share price.
 

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article 3 months old

Qantas Set To Retest Lows

By Michael Gable 

We have seen a fantastic performance in the market during the last two weeks where it has rallied from around 5150 to 5450 in that brief period of time. Everyone that we talk to can understand the reasons why the market will be robust, but no-one appears to be admitting to us behind the scenes that a 300 point rally in two weeks was to be expected.

Our new model portfolio which is restricted to the top 200 stocks is off to a good start. Since introducing it last week, it has slightly outperformed the market. One week doesn’t count for much at all of course, but with a very conservative cash holding of 13% to start with, logic tells you to expect underperformance when markets rally very strongly. With a lot of firepower in reserve, we are well placed to take advantage of any cooling off in the market. So while it is early days, we feel that it’s a good omen for the months ahead.
 

Qantas


 

Our last update for Qantas ((QAN)) was on 1 October when it as trading at $1.51. At the time we stated “Now that is struggling to surpass our target and the sugar rush from last month’s results are wearing off, we expect the share price to fall back into the $1.30 - $1.40 zone.” Not only did it fall, but it went as low as $1.245 on very large volume. This share price action is telling us that there is a good chance that it will at some point retest the August low at $1.185. At that point there may be another technical trade in it on the long side, but we will have to reassess at that point.
 

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

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

Michael is RG146 Accredited and holds the following formal qualifications:

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

Disclaimer

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

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article 3 months old

Coal Is Bright For Asciano

-Coal exports strong, rail weak
-No evidence of economic recovery
-Still plenty of positive aspects
 

By Eva Brocklehurst

Coal export volumes may be growing strongly, particularly in Queensland, but there's no evidence a domestic cyclical recovery is loading up other parts of Asciano's ((AIO)) container, ports and haulage business. The company has downgraded guidance and expects profit, ex material items, to be flat in FY14. Underlying earnings growth is expected to be below FY13, which in Macquarie's calculations implies 0-13% growth. The guidance highlights a lack of volume in a very high fixed cost business.

After a downgrade to guidance one would expect brokers to take a razor to ratings but Asciano remains Citi's preferred exposure for an economic recovery in the transport sector, some of which is expected in the second half. Supported by above-market growth in coal, and gains in terminals, the majority of the business looks solid to the broker. JP Morgan is also upbeat and thinks the investment Asciano is making to expand capacity and achieve increased productivity and efficiencies will place it in a strong position to leverage off any improvement in economic conditions. The broker is also encouraged by the lift in coal volumes and the increased hauled/contract volume ratio.

Macquarie is waiting for the recovery train. The share price may have improved dramatically over the past several months but there has been nothing in the business to warrant this and the stock has been downgraded to Underperform from Neutral. Macquarie stands alone on the FNArena database, where the stock has seven others with Buy ratings. The price target is $6.26 on consensus estimates, which is signalling 7.1% upside to the last share price. The range of targets is $5.48 to $6.73.

Coal tonnage was up 16.5% and supported by a 13.9% increase in average haulage length in the September quarter. This provided some offset to the fact that Pacific National's rail's intermodal volumes were down 2.6%. Citi views this as a reflection of a weak revenue environment that has countered any savings the company has made in the division. Asciano continues to expect difficult conditions for the rail, terminals and logistics segments. Intermodal rail is of most concern as it is a fixed cost business and volumes are soft. Nevertheless, there appears to be no loss of market share and JP Morgan expects bulk grain should pick up in December.

While coal exports are growing strongly, Morgan Stanley is also mindful that expectations of a domestic cyclical recovery are yet to be met. The broker wants to see accretive acquisitions, significant savings and a genuine cyclical recovery before letting off the brakes. Forecast earnings growth has been trimmed for FY14 to 5% compared with the 12% growth seen in FY13.

Container volume grew by 6% in the quarter and this was ahead of industry growth of 2-3%. It appears Asciano gained market share but Morgan Stanley warns of the volatile nature in the consolidation of shipping. Asciano expects a slowing of industry container volumes to 1-2% for FY14. Morgan Stanley assumes Asciano can extract $185m in savings compared with the initial target of $150m over FY12-16 but earnings margins are still expected to fall and a higher cost of debt contributes to the broker's expectations of normalised profit falling by 4% in FY14 to be just 2% higher than FY13.

Despite a stronger quarter of container volumes across the ports, management pointed to a slowing in the lead up to Christmas and Macquarie expects this weakness will become more apparent in coming months. The broker was most disappointed by rail, with weakening demand in Western Australia leading to falling earnings expectations for the year. In contrast, coal growth was strong but this was only in line with expectations and largely on the back of miners trying to maximise volumes. Macquarie was surprised to note the volumes are pointing to Xstrata's haulage picking up the majority of coal growth in NSW.

These are near-term headwinds in BA-Merrill Lynch's opinion but the Buy thesis is intact. Market share in terminals has rebounded to 49% during the quarter, up from 47% at the end of FY13. The 97% on-time coastal performance is at an all-time high and Asciano has effectively contracted 75% of its container volumes to 2017. Other positives for Merrills include the business improvement program, making the broker comfortable about the $22m in savings factored in for FY14.

Credit Suisse also thinks the intermodal volumes, while disappointing, mask strong results from coal and ports. The broker has lowered earnings forecasts by around 5% to reflect a delay in economic recovery but, should management go easy on acquisitions and focus on execution, then the scope for dividends is large. FY15 free cash flow yield is currently at 7.4% and growing for subsequent years. Moreover, Credit Suisse observes the growth in cash flow is more leveraged to the contracted expansion of the coal business rather than the underperforming rail.

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article 3 months old

Weekly Broker Wrap: Telematics, Media, Broadband, Wealth and Transport

-Telematics take up likely to be slow
-What's likely on media reform agenda?
-Broadband returns decline, mostly for Telstra
-What issues ahead for diversified financials?
-Picking the best in subdued transport sector
 

By Eva Brocklehurst

What is telematics? Morgan Stanley has a survey which shows that 20% of Australian motorists are ready to give telematics insurance a go. Telematics measures how, when and where you drive in order to price insurance more precisely for the individual. The insured connects a BlackBerry-sized device to the car and that connects with GPS and mobile networks. All cars made from 2000 onwards are capable of telematics. The device can track location, and driving behaviour such as accelerating and braking as well as swerving and lane-switching. An actuarial logarithm then translates this data into a behavioural risk score. Presto! You're measured for insurance.

Morgan Stanley observes that, unlike the UK where the market is three years old, Australia does not have widespread market pricing failures that would accelerate the adoption of telematics. Moreover, in the US and UK insurance combines bodily injury and motor, making the economics more compelling. Telematics has a 0.6% share of the UK market and in the US, where penetration is higher, it's estimated at 2-3%. So it's not likely to take off like a rocket.

Morgan Stanley thinks that once telematics gains initial acceptance here it will fuel its own growth as community rating systems break down. The insurer absorbs the costs of the device which could cost $100 but Morgan Stanley thinks the economics make sense on a policy over $900. Telematics calls for more underwriting and more data handling, including the cost of connecting to a mobile network. The potential to bundle with CTP green slips would make it even more attractive. The benefits for insurers include the fact that less risky drivers are likely to select telematics first, and there'll be higher retention of such customers once they're "connected". Morgan Stanley thinks, eventually, car manufacturers, or telcos for that matter, risk displacing direct motor insurers if they do not enter this market. While the analysts at Morgan Stanley think this option is inevitable it is unlikely to grow fast. They estimate the current market potential is around 7%, but expect this to rise as technology gets cheaper and major insurers get involved.

The change in the federal government has caused JP Morgan to put a spotlight on potential media regulation reform. Such reforms are more likely to occur in FY15. The potential list includes the scrapping of the 75% reach rule and a review of the 4.5% FTA licence fee. The scrapping of the 75% reach rule is likely to be a trigger for regional and metro consolidation in the industry. In June a parliamentary committee supported the removal of the rule. The committee was of the view that the rule was becoming redundant with the advent of the internet and converging media. JP Morgan considers the most likely beneficiaries of the scrapping of the rule would be Prime Media ((PRT)) and Southern Cross Media ((SXL)). In the case of the potential review of the Free-To-Air licence fee, JP Morgan rates a reduction as a one-in-three chance.

In a speech to parliament earlier this year the now Minister-elect for Communications/Broadband, Malcolm Turnbull, noted that Australian FTA fees were relatively high by global standards. Should these fees be reduced further, JP Morgan would expect further legislative requirements for FTA stations, such as increased Australian content obligations. Modelling for a 0.5% and 1% reduction scenario, the FY15 earnings estimate for Seven West Media ((SWM)) rises 2% and 4% respectively. For the Ten Network ((TEN)) it rises 6% and 12% respectively.

Australian telcos may have attractive dividend yields of 5.3% for FY14 forecasts but Morgan Stanley thinks the 10-year government bonds at 4% offer a justifiable alternative. Slowing Free Cash Flow growth and the decline that's expected in broadband industry returns underpin the broker's Underweight call on Telstra ((TLS)). In contrast, NBN-driven regional share gains should see increasing returns for the likes of iiNet ((IIN)) and the broker is Overweight on that stock. Profit taking has been dominant in the telco sector recently but Morgan Stanley still views iiNet, TPG Telecom ((TPM)) and Singapore Telecom ((SGT)) as attractive.

Why does Morgan Stanley think Telstra's returns will decline? Telstra's competitors have new mobile pricing plans which could see a potential change in market share and this is yet to be priced in by the market. Based on the broker's analysis these are not domestic price decreases, so a seven times EV/EBITDA multiple is still applied to Telstra's mobile business, in line with global peers. Changes to international roaming fees are one genuine change to the industry, which could inspire consumers to move away from Telstra. Morgan Stanley expects Telstra to gain 0.5 percentage points of mobile market share in FY14. 

What the broker finds a major problem with is the market pricing in declining returns for all players. Broadband industry returns are set to decline, yet smaller ISPs, such as iiNet are expected to increase returns and take regional market share. Hence, Telstra's price/earnings ratio should contract to 14 times from 15 times on slowing cash flow growth, in the broker's view. The company's 3-year FCF compound annual growth rate should slow to 7-8% from 12-15%. Historically this measure is a predictor of multiples expansion and, hence, a slowing rate means multiples compression.

Citi has changed some calls on the diversified financial sector in the wake of reporting season. The broker lifted ratings on Perpetual ((PPT)) to Neutral and dropped Henderson Group ((HGG)) and IOOF ((IFL)) to Neutral. The broker became significantly more positive on Challenger ((CGF)), lifting it to Buy, following the best annual result in a very long while.

What has Citi deduced from the results overall? Equity market performance is still key to the sector performance with Henderson, IOOF and Perpertual earnings strongly leveraged to markets. ASX ((ASX)) and Computershare ((CPU)) are positively leveraged to trading and corporate actions. Citi maintains Computershare is the most leveraged it has ever been to short-dated interest rates. Despite the low interest rates, annuity sales momentum also looked strong in June and continued into July and August. While not out of the woods, the broker suspects funds management may be past a turning point.

IOOF has revenue pressures, including platform margin pressure, but cost control is a mitigating factor for Citi, even if IOOF is unsuccessful in its bid for Trust Co ((TRU)). Counter bidder Perpetual is relatively expensive, but Trust is seen as a worthwhile accretive acquisition. Meanwhile, ASX is considered relatively safe but unexciting. There is little sign of IPO or secondary capital raisings picking up materially, and new initiatives such as collateral management and OTC clearing are not expected to make a substantial difference for some time. Derivatives volumes did rise in FY13 but, in Citi's opinion, if interest rates are more stable then these too may subside.

Soft economic conditions and slowing resources activity meant a challenging end to FY13 for the transport industry. CIMB notes growth was below that recorded in the first half for all stocks except Toll Holdings ((TOL)) and Qantas ((QAN)). Toll was cycling a weak result in the second half of 2012, while Qantas benefited from an accounting estimates change. Overall, the airlines were hit the hardest as a combination of excess capacity in the domestic market and weak demand affected yields. Logistics operators, such as Toll, Brambles ((BXB)) and Qube Logistics ((QUB)) faced sluggish consumer demand, while Asciano ((AIO)) and Aurizon ((AZJ)) faced a softening coal market. All this is expected to persist in FY14, making earnings growth a challenge in the year ahead.

Qantas and Virgin Australia ((VAH)) have the most risk going forward because of excess capacity in the market and soft demand, according to CIMB. Toll and Qube also have risks, given the continued weakness in the broader economy and their exposure to the resources industry. Less risky are Asciano, Aurizon and Brambles. Brambles was re-rated Outperform at the FY13 result as CIMB thinks valuation multiples are now more reasonable. The broker's other key picks are Asciano, for its double-digit earnings growth profile combined with attractive valuation multiples, and Qantas, where there's an opportunity to add some cyclical risk to the portfolio with limited downside. CIMB finds downside risks continue for Virgin Australia while Toll and Qube are starting to trade above fair fundamental valuation.
 

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article 3 months old

Transport Sector Trundles Along In Low Gear

-Coal production keeps haulage up
-Airline demand affected by lower AUD
-Qantas alliance benefit seen in FY15
 

By Eva Brocklehurst

Transport, overall, is suffering from an uncertain outlook. Domestically and globally. Domestic freight volume is subdued. Airline capacity may have moderated but demand is still soft.

Asciano ((AIO)) expects difficult market conditions in the coal haulage area to continue in FY14, guiding to container volume growth of a bare 1-2%, while intermodal volumes are expected to be flat. Given the high fixed cost nature of the terminal and rail businesses the company is highly leveraged to any improvement in volume. Despite this, Deutsche Bank can see potential for Asciano to be re-rated if the company continues to execute as well as it did in FY13. Nevertheless, much of the near term growth in coal volumes is being driven by contracted volumes. Goldman Sachs assumes some growth will come organically, amid improved contract utilisation. The broker does remark that 95% of the coal haulage contracts are take or pay, with an average duration of seven years.

Asciano has reported that some miners have sought contract relief and has been developing new services to address these changing customer requirements and increased competition. Asciano has emphasised it will only make concessions where they enhance value but Goldman suspects any concessions will have a short term earnings impact.

Aurizon ((AZJ)) surprised several brokers by delivering a final dividend of 8.2c in FY13. Given the majority of Aurizon's volume is still on legacy contracts, Goldman Sachs expect some margin improvement as contracts roll over. Aurizon's management has stated that coal haulage volumes started FY14 strongly. Production and export volumes for the industry support this, in Deutsche Bank's view, with production up 18.1% for the four largest Australian producers in the final quarter of FY13 against a rise of 10.1% in coal exports.

Linked to this strength in Aurizon's haulage, is Royal Wolf Holdings ((RWH)), which has won a contract in the freight division to supply Aurizon, with a total sales value of $12m. Deutsche Bank notes that this contract alone will mean a doubling of revenue for the division in FY14, although it will be at much lower margin than the rest of the business as Aurizon will want competitive pricing. Otherwise, this company has also indicated underlying conditions remain difficult with average utilisation of the lease fleet down to 82%.

Similarly, Toll Holdings ((TOL)) noted activity levels to date are yet to show any sign of improvement, highlighting that weak business confidence and a tough competitive environment represent ongoing challenges. Toll is also being more disciplined on costs and strategy but what clouds Deutsche Bank's view is this company has less earnings visibility than either Aurizon or Asciano. The three making up Deutsche Bank's Buy recommendations in the large cap transport sector are Asciano, Aurizon and Toll.

Above ground level, moderation in domestic airline capacity continues but demand remains soft, according to Goldman Sachs. Domestic system capacity growth was 3% in July, continuing the more moderate capacity growth seen towards the end of FY13. Given the softer trends in passenger numbers at the capital city airports, soft demand means that the capacity added over FY13 will take some time to absorb and hence weigh against yield growth, in the broker's opinion.

Deutsche Bank notes Qantas ((QAN)) was the best performer in the three days after the results, given strong cash flow, and Brambles ((BXB)) the worst, because of the FY14 outlook. Brambles is yet to see any incremental consumer demand in the US but expects new business won in FY13 will contribute over US$60m in revenue in FY14. The Recall de-merger is on track and is planned for December this year. Brambles is no longer a top pick for Deutsche Bank and is now a Hold recommendation. Qantas continues to be rated a Buy.

JP Morgan recently attended the Centre for Aviation's (CAPA) Australia Pacific summit. The broker retains an Underweight on Australian airlines Qantas and Virgin Australia ((VAH)) and Sydney Airport ((SYD)). In the airline sector presenters highlighted the opportunities to capitalise on the growing middle class population in many Asian countries and emphasised that China should be seen as a number of discrete large markets. Most presenters believe that Australia and New Zealand are well placed to benefit from the growth in the middle class demographics across the Asian region over the medium to long term. Australia currently captures only a small percentage of the targeted growth markets of China, India, Philippines, Malaysia, Indonesia and Vietnam.

Nevertheless, there are short-term head winds. The 15% devaluation of the Australian dollar has already seen a 15% reduction in forward bookings. Many foreign carriers increased capacity on routes to Australia after the GFC, reflecting the relative strength of the Australian economy. This resulted in a high percentage of tickets originating in Australia, in Australian dollars. CAPA estimates that 70% of bookings for international flights to/from Australia originate from Australia and foreign carriers would be starting to see lower US dollar translated revenues as a result. They could decide to reduce the frequency of services and even cut routes if the routes ultimately become unprofitable. This may not happen straight away but should be positive for Qantas and Virgin Australia, in JP Morgan's view. It may not be so good for Sydney if passenger growth slows.

The CAPA summit also talked about partnerships and global alliances. Airlines are taking a more realistic and pragmatic approach to creating networks. The partnership between Qantas and Emirates was one example cited, where Qantas' membership of the One World Alliance did not prohibit Qantas from forming a partnership with a non-member. A similar example is the partnership between Virgin Australia with both Singapore and Air New Zealand, which are members of the Star Alliance. The creation of extensive virtual networks is expected to be a feature of most international carriers in the future. JP Morgan notes there is a divergence of opinion as to whether a low cost airline can co-exist alongside a full service airline and it appears to be mostly a phenomenon of the pan Asian region.

On the Qantas alliance with Emirates, Deutsche Bank observes benefits are not expected to fully arrive until FY15, whereas previous guidance indicated that a large part would be delivered in FY14. No specific benefit targets have been given but the broker estimates that for Qantas International to reach a break-even point by FY15, around $100m in contribution from the Emirates alliance is required. As for Virgin Australia, FY14 should see a better financial result, but Deutsche Bank thinks it will struggle to achieve more than break even because of the tough underlying conditions and high fuel prices. Despite operating cash flow EBITDA conversion of 97%, the company has sought a shareholder loan from its three major shareholders for $90m to bolster liquidity. If economic conditions worsen or an industry shock occurs then the broker thinks Virgin Australia will be left with little option but to undertake sale and lease back transactions, or raise equity.

The other aspect of domestic air travel is the mining sector. As much as 25% of the mining workforce is fly-in-fly-out (FIFO), approximately 100,000 workers. Travel management companies are now doing a lot of the logistics behind rostering and providing a duty of care for the mining companies. JP Morgan observed the FIFO sections of Virgin Australia and Qantas commented that, whilst the construction phase of the mining boom was largely over, the mines were going into an operational phase where the actual passenger movements will become more regular. That is, fewer people are travelling but those that are, fly more often. The broker notes the speed and size of the mining boom made for a huge increase in capacity in the FIFO market that was becoming unsustainable. Now, the focus is on efficiency.

A last word on another transport stock - mid tier K&S Corp ((KSC)). The company's earnings are tied to the resources sector, primarily through its Western Australian-based Regal Transport business. K&S is seen more exposed to a resources slowdown than other similar sized transport providers. Deutsche Bank will monitor this area very closely as it continues to be a source of risk for the company. The broker retains a Buy rating.
 

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