Tag Archives: Transport

article 3 months old

Weekly Broker Wrap: Aust Healthcare, Building, Retail, Gaming And Transport

-Solid defensives in Aust healthcare
-Conflicting stories in building
-Discretionary retail trends diverge
-Aust gaming subdued
-Transport dividends up

 

By Eva Brocklehurst

Australia's healthcare sector retains some attractive defensive characteristics but the valuations are not generally defensive, in Morgan Stanley's view. ResMed ((RMD)) holds the most upside potential for the broker. Sonic Healthcare ((SHL)) was upgraded to Overweight during August, joining ResMed, Primary Health Care ((PRY)) and Sigma Pharmaceuticals ((SIP)) in the category.

Morgan Stanley had been concerned that Sonic would miss expectations as a result of fee cuts across major geographies and a benign US volume environment. FY13 results surprised, however, and this provides a higher forecasting base. The broker understands that execution of the US cost cutting program is now complete and benefits are expected in FY14. This cost cutting may negate most known fee cuts in FY14 and provide the platform for growth which the broker was previously skeptical about. Sonic is considered a defensive volume growth story.

US device growth at 16% in FY13 was in line with expectations and ResMed benefitted from the shifting of the mix as home sleep testing accounts for a greater proportion of prescriptions. Mask sales growth in the US was over 8% in the second quarter but ResMed lost share. The broker expects new releases will claw back this lost share and revenue could surprise on the upside if the new devices gain traction. Home Sleep testing now accounts for over 30% of US volumes and is expected to approach 40% over the next year. The competitive bidding pricing is already known for the bulk of round two contract winners and this leaves ResMed with good forward visibility and confidence in the outlook.

Building materials stocks have seen price/earnings re-rating that was ahead of results, in anticipation of a growth recovery. Morgan Stanley thinks FY14 will provide some growth but for the most part consensus expectations are seen as still too high for the broker's liking. The most preferred stock is DuluxGroup ((DLX)), a high quality company generating a high return which justifies its P/E premium, in Morgan Stanley's opinion. Dulux has more defensive earnings characteristics than other building materials stocks, but still offers solid growth prospects. Earnings upside may come from a sharp fall in the titanium dioxide price, which is a significant input cost to paint. Working capital opportunities in the former Alesco businesses could drive further upside.

The broker's least preferred stocks are Fletcher Building ((FBU)) and CSR ((CSR)). Fletcher is exposed to a recovery in the New Zealand housing market, where it is the leading player through its vertical offering. This is the main positive. There is no FY14 guidance, and consensus expectations for FY14 and FY15 appear aggressive to Morgan Stanley. Revenue looks light across most of the divisions. No significant volume growth is expected in Australia while North America remains mixed - positive on the residential but flat on the commercial side.

CSR is positioned for a recovery in the Australian residential market but the broker sees challenges within aluminum and the Viridian turnaround requires proof. CSR offers some of the best exposure to an improving east coast property market but it's not enough to change an Underweight recommendation. Strength in building products is offset by execution risk in Viridian and risks around the aluminium assets.

JP Morgan has taken a look at the US operations of Boral ((BLD)) and James Hardie ((JHX)). Boral's performance through the downturn has mirrored that of the broader construction industry, i.e. spiralling losses, followed by deep capacity cuts and restructuring efforts. The future of the US business hinges on a number of factors, in the broker's opinion, principal among these being a recovery in brick intensity.

In contrast, James Hardie's performance through the downturn has been exceptional as it is one of the few building-related entities in the US to remain comfortably profitable. In fibre cement James Hardie stands out with a differentiated product and high market share. Boral has been affected by the volatility that is typical of fragmented industries such as bricks and tiles. In terms of pricing,  brick and tile that was resilient, although future increases will need to be considerable to restore returns, in JP Morgan's view. Again, in contrast, James Hardie has battled on the price front.

Australian retailers had a stronger second half of FY13 with earnings up 4% relative to the 3% lift in the first half. UBS finds household goods in terms of JB Hi-Fi ((JBH)) and supermarkets in terms of Woolworths ((WOW)) reported the strongest results. Billabong ((BBG)) and Pacific Brands ((PBG)) were notably soft.

For the staples, reactions were mixed while results were in line. Whereas Wesfarmers ((WES)) fell as the softer second half for Coles was construed negatively, despite Wesfarmers announcing a capital return, Woolworths ((WOW)) performed strongly, as the market reacted to the upbeat commentary on FY14 momentum. UBS views the grocery sector as fair value, but thinks Woolworths has the greatest scope to outperform. The third player, Metcash ((MTS)) sustained 5-10% downgrades in the wake of its AGM, as IGA sales were reported to be hit by heightened levels of fuel discounts by the major chains.

In discretionary retailing the trends parted. Household goods, underpinned by improving house prices, performed well while the department store/fashion area was soft. Looking forward, UBS expects this trend to continue, with increased competition in fashion to present a risk to department store forecasts and an improving housing backdrop to provide upside to those stocks such as Harvey Norman ((HVN)) and JB Hi-Fi.

Crown ((CWN)) and Aristocrat ((ALL)) remain Deutsche Bank's favoured stocks in the gaming sector. Australian gambling expenditure is expected to remain subdued through the remainder of 2013. Crown will benefit from its exposure to the higher growth Macau and Perth markets and has introduced some cost reduction initiatives in order to offset the weaker trends at Crown Melbourne. Aristocrat is sustained by the fact it generates just 27% of earnings from Australia. Of note to the broker, Crown and Tabcorp ((TAH)) were unusually quiet about trading in July and August. Echo Entertainment ((EGP)) and Tatts ((TTS)) reported positive trends. Echo was boosted by strong growth in the VIP segment while Tatts benefited from a favourable jackpotting sequence in lotteries.

The weakness previously seen in gaming machine expenditure has also affected gaming tables, and there's been a softening in wagering and keno expenditure. Conversely, lotteries expenditure has remained buoyant, although Deutsche Bank thinks this can largely be explained by the favourable jackpotting sequence. In order to offset the weaker than anticipated top line growth, some of the companies introduced cost reduction initiatives and there is an increased focus on cost control and margin improvement.

Transport produced three main themes from the earnings season. In Deutsche Bank's view, these are cost reductions, higher dividends and an uncertain outlook. Most results were in line with forecasts. Qantas ((QAN)) showed the largest variance because of an accounting adjustment to the treatment of ticket revenue. Dividends were generally higher, with Aurizon ((AZJ)) standing out. Asciano ((AIO)), Royal Wolf ((RWH)) and Toll Holdings ((TOL)) all delivered better-than-expected dividends. The changes to FY14 earnings expectations were mostly small, with the airlines being the largest downgrades on the back of fuel and capacity/yield pressures.

Deutsche Bank now has three Buy recommendations in the large cap transport space, these being Asciano, Aurizon and Toll. Toll is being more disciplined on costs and strategy but has less earnings visibility than the other two. Brambles ((BXB)) is no longer a top pick and was downgraded to Hold from Buy during the earnings season.
 

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article 3 months old

Can Virgin Australia Turn Around?

-Load factor key to FY14 turnaround
-Domestic bookings improving
-Cash liquidity a concern
 

By Eva Brocklehurst

Virgin Australia ((VAH)) has made a last minute downgrade to FY13 guidance, now expecting a net loss. Results are expected on August 30. Brokers are still hopeful that FY14 will turn around, and industry statistics suggest, at the very least, the domestic market is stabilising. Still, a downgrade is a downgrade and a sign that Virgin Australia is struggling in a competitive market.

UBS is in line with FY13 guidance, for a net loss of $100m (guidance $95-110m). The profit guidance includes, as yet undisclosed, mark-to-market gains on fuel hedging and, depending on how much of this is deemed as below the line, this could result in a large underlying pre-tax loss. UBS has reduced future earnings estimates by 20%. FY14 is now expected to show a pre-tax profit of $80m. The downgrade wipes 10% off book value for UBS but of greater concern is cash liquidity. This is likely to fall to $250m, representing a slim 6% of forward revenue. Too low in the the broker's view. Downgrade to Neutral from Buy is the call.

Management has flagged a number of initiatives to unlock further liquidity such as securitising latent equity in the fleet. This is likely to take some time and heighten the sensitivity to earnings shocks. Of note, 67% of the share register is owned by strategic investors and this could provide investors with some capital protection as well as act as a source of equity if needed. Unit revenue is expected to expand at a greater pace than costs in FY14 and this should help turn things round. Costs contributing to the downgrade were transition to the Sabre booking system, transaction expenses relating to Skywest and Tiger and asset impairments. JP Morgan suspects many of these cost should have been known earlier.

CIMB thinks, while FY14 should be better for the industry as a whole, if management doesn't improve the load factor, the likelihood of another downgrade will increase. The broker thinks Virgin Australia dug a hole by chasing yield in the second half at the expense of maintaining a healthy load factor. This needs to be addressed to generate a profit in FY14. CIMB does expect the domestic load factor to improve to 77.5% from 75% and this should drive a pre-tax profit of $31m.

In the end, revenue quality needs to improve as well and, underpinning this, signs of stalbilsation in the domestic market. Virgin Australia has signalled a 6% rise in forward bookings and strong feed from alliances. Nevertheless, a deterioration in operating profits in such a relatively short time frame and pressure on costs as Australian dollar hedges roll off worries JP Morgan. The broker had expected a FY13 net loss around $2.4m.The risks are seen weighted to the downside now and the stock was downgraded to Underweight from Neutral.

Despite this setback, Credit Suisse believes the company still offers investors a structural growth profile in the Australian regional, leisure and corporate market. Trunk sectors are where Jetstar ((QAN)) is competing the most aggressively against Virgin Australia and likely where much of the load factor and yield weakness is concentrated. Credit Suisse maintains an Outperform rating. The broker is encouraged by the positive comments from management regarding further load factor improvement in July, the rise in forward domestic bookings and more normal FY14 capacity growth. That being said, should earnings continue to disappoint, the market's patience is expected to be sorely tested. Credit Suisse expects debt serving levels to return to more normal levels but, should planned transformation benefits not materialise, an equity raising could be on the cards.

Citi was the third broker on the FNArena database to downgrade the stock in the wake of the news - to Sell from Neutral. The increase in domestic yields is a positive but Citi thinks this is mainly driven by benefits of the new global distribution system. The broker believes Virgin Australia is still missing late, and high yielding, bookings, and this needs to be addressed. Citi is cautious on any recovery in FY14, given lack of visibility on the earnings profile and higher fuel costs. The best that can be said is that FY14 is dependent on a more rational domestic market and this is being seen. Nevertheless, for Citi, value exists elsewhere in the sector.

Challenges abound. These include improvements to the financial position of Skywest and coordinating the joint strategy with Tiger Air as well as the RASK (revenue per available seat kilometre) performance of the Virgin brand. Citi suspects, while the support of strategic shareholders indicates limited downside to the share price, the stock is unlikely to outperform the market. That's even in the event of a takeover, which the broker considers likely.

So what's the verdict? Take your pick. On the database there are three Buy ratings, two Hold and three Sell. The consensus target price is 45c, signaling 10.6% upside to the last share price. The range of targets is 35c to 56c.
 

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article 3 months old

Brambles Totals Recall

-Recall de-merger to simplify Brambles
-Attractive to two different investor types
-Broker focus on structural issues
-Weak paper pricing a factor
 

By Eva Brocklehurst

Brokers have welcomed Brambles' ((BXB)) decision to hive off its Recall business into a separate ASX-listed entity by the end of the year. The move simplifies the remaining business and, as CIMB observes, de-mergers are typically rewarded by the sharemarket.

Recall specialises in storage, secure destruction of documents and data protection. The main source of revenue is derived from North America and Brazil with just 30% coming form Australia. Brambles had previously tried to divest Recall but acceptable price and terms were not forthcoming. Earnings for FY13 are expected to be around US$140-144 million and there is US$450m in net debt attached to the new entity.

Macquarie found this guidance below expectations, reflecting soft transaction volumes in Europe as well as a normalisation of sales and marketing costs where there was likely to have been a level of underinvestment in FY12. Despite this, Brambles is confident Recall can deliver revenue and profit growth in FY14 and cash flow should support a strong dividend. Franking will be limited, given the smaller percentage of revenue in Australia. Deutsche Bank values a de-merged Recall business at around 88c a share while Credit Suisse believes Recall could be worth $1.26 a share. Macquarie expects Recall could trade around eight times FY14 earnings forecasts and support a potential dividend yield of 5%.

The de-merger is seen as a positive step as management in each business can focus capital and time on core activities. For Credit Suisse, this means investors need to consider the issues that are facing the Recall business such as structural challenges in physical document storage and whether management pursues a growth or yield strategy, as well as operation and capital expenditure requirements. Then there's the digitising of offices and the extent of the reduction in physical paper documentation. Recall will need to demonstrate a focus on growing data protection services, which accounted for around 10% of FY12 revenue. Brambles does not think digitisation is a threat and has pointed to an increase in regulation requiring companies to hold more documents as evidenced by growth in carton volumes.

The company's outlook for Recall shows a 3% decline in constant currency revenue. While this was consistent with the third quarter update, it reveals that revenue probably did not deteriorate further in the fourth quarter. Management highlighted continued weakness in paper prices as well as slow volumes in transactional revenue. Credit Suisse maintains that cyclical revenue streams, while accounting for only 38% of earnings, have a disproportionately large impact on the business because of the high margin nature. This has been characterised by weak merger and acquisition activity which has meant lower demand for some services. The other significant pressure is weak paper pricing. Paper recycling accounts for only 4% of revenue but it is a volatile business. Macquarie believes this volatility underpins the company's struggle to live up to the premium growth story but also suspects the unsuccessful sale process has not helped.

Credit Suisse thinks the market should look beyond these issues towards structural themes but admits that, if cyclical weakness persists, Recall may find it challenging to appeal to yield-focused investors. Recall continues to grow annual carton holdings, countering the argument that the underlying business is in decline and with some new business wins the broker considers there's a strong case for growth opportunities ahead. Deutsche Bank believes a different class of investor will be attracted to the higher yielding but lower growth investment that Recall represents. Macquarie maintains this theme as well. The two businesses are at different levels of maturity and likely to attract different investors. Large parts of Brambles' residual businesses are in a strong growth phase while Recall has higher free cash flow because of the annuity style revenues.

What does the de-merger augur for the parent? Brambles will focus on pallets, containers and reusable plastic containers (RPC). Deutsche Bank was encouraged by the unchanged guidance for FY13 earnings, being US$1.03-1.06 billion. After the de-merger Brambles can focus on the high growth pooling operations under the CHEP and IFCO brands. CIMB believes trading after the de-merger will likely favour Brambles as the majority of current shareholders have based investment decisions on the pallet businesses that will remain with Brambles. Macquarie will be watching to see whether Brambles can maintain or improve the momentum in the RPC and containers business to justify the recent investment in this area.

Brambles has a mixed coverage on the FNArena database. There are three Buy ratings, two Hold and one Sell. The targets range from $8.34 to $10.21. The consensus target is $9.61, signalling 3.6% upside from the last closing price. For Credit Suisse, the recent share price strength means, although Brambles is the highest quality stock in the Australian transport sector, at current multiples a Neutral rating is appropriate. CIMB retains an Underperform rating, as the stock is trading on 18 times FY14 price/earnings forecasts. With an Outperform rating, Macquarie is focused on Brambles' leverage to the falling Australian dollar and the FY14 outlook, conscious of the elevated trading multiples. Ex Recall, the core business is trading on around 10.1 times Macquarie's FY14 earnings forecasts.
 

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article 3 months old

Weekly Broker Wrap: Elections, Aussie Dollar And Retailing

- Weaker AUD not a universal blessing for Australia
- Times predicted to remain tough for retailers in Australia
- A new paradigm for energy retailers
- Qube Logistics could be a winner post federal elections
 

By Rudi Filapek-Vandyck

It is easy to get carried away by assuming that a weaker Aussie dollar must have positive implications for the Australian economy and for profits of Australian listed companies, warned Tim Toohey and his fellow-economists at Goldman Sachs this week.

Sure, there are foreign companies that sell a lot overseas and the translation of those profits will be beneficial for Australian shareholders at a lower AUD, but beyond this translation impact any assessment is much more difficult to make. There's more at work than simply a one-on-one translation.

One thing the Goldman Sachs economists do not deny is that recent weakness for AUD will have been welcomed inside RBA headquarters. It takes off the pressure to put even more monetary stimulus into what arguably is a still weak and further weakening economy.

Such a view is supported by peers at Macquarie who this week reported a 10% fall in the AUD should boost domestic economic growth by 0.25ppt after a year and inflation by 0.50ppt. With the RBA previously forecasting inflation at 2% by the end of 2013, and 2.5% in mid 2014, Macquarie believes it remains quite plausible that inflation will remain inside the RBA's target band over that period. This despite other voices elsewhere suggesting higher inflation might become the new threat.

As per always, the devil remains in the detail and both economists at Goldmans and Macquarie agree the present uncertainties are related to the reasons behind the weakness for the domestic currency. Is it because China's growth will disappoint even more? Is it because the RBA will have to cut the cash rate even further (which would imply weaker than anticipated domestic momentum)? Or is it solely because of a stronger-than-expected US economy?

Within these parameters, there's a plethora of variations possible and all have different implications for Australia's economy and for corporate profits. It really is tough to be an economist these days. Maybe, just maybe, being the sitting Prime Minister in Canberra might be worse.

One sector that will be impacted by the weaker AUD are the local retailers, and it will be negative at first. This because most retailers source produce from overseas. These imports are now quickly becoming more expensive, hence triggering pressure on margins.

It gets even worse. Goldman Sachs this week also pushed out its anticipated pick-up in domestic retail spending. Not that expectations were high in the first place, but the pending pick-up is now anticipated to be more of a 2014 story. Combine the two factors and it should be no surprise as to why earnings estimates for retailers have taken another hit during the week.

Wesfarmers ((WES)), which partially sells in USD, remains Goldmans' favourite in the consumer staples space, while Harvey Norman ((HVN)) is preferred among discretionary retailers.

Adding further grist to the mill for the shorters in the Australian share market (and retail remains a favourite target), Citi analysts are anticipating rather dismal results for fashion retailers in August. After a strong month in January, sales have been poor in the first six months of calendar 2013 for the clothing, footwear and accessories segments, note Citi analysts. Retailers all blame warm weather and politics, but electronics retailers seem to be trading fine with the same economic backdrop, the analysts add.

Their verdict: consensus estimates are too high. Investors better prepare for disappointments.

Both Goldman Sachs and Citi rate David Jones ((DJS)) as a Sell. They are far from the only ones. Half of all stockbrokers in the FNArena universe currently rates David Jones a sell or equivalent rating. The other half doesn't dare to go further than Neutral/Hold.

The week past opened with yet another sector update by Citi which allowed the analysts to identify one extra disadvantage for bricks and mortar retailers vis-a-vis their online competition: Australian laws that prevent retailers from trading long hours on Sundays and certain public holidays. Online retail does not have such limitations. Citi does believe relief will come via changing laws, and lesser restrictions, but it also believes the eventual upside for retailers from this will remain limited to something like 1% in profits. Hardly the kind of stuff that causes investors' hearts to skip a beat.

Other items that featured prominently in broker research throughout the weak included (even) lower price forecasts for commodities, with gold featuring prominently in what appears to be the new $64 million question in and around Sydney's Bridge Street: how low can it go? Note also that on Citi's latest research, no less than 90% of all goldminers across the globe are not making any money at present prices (see Friday's story "Treasure Chest: Gold Miners In Survival Struggle"). US president Obama's strong support for climate change action also triggered research responses, all painting a potentially favourable background for natural gas in the decade ahead.

Analysts at BA-ML announced the beginning of a new era ("paradigm") for energy retailers in Australia. The trigger was provided by Origin Energy ((ORG)) announcing it will cease door-to-door sales from September onwards. BA-ML analysts believe the industry as a whole can now look forward to a period of stabilising margins and steady churn. If you happen to think this is not exceptionally attractive, then consider the past era comprised of declining margins, growing churn, and aggressive discounting. While margins are expected to remain on the low side, there might be additional upside from further deregulation in Queensland and NSW, predicts BA-ML.

The analysts have started to remove carbon tax impacts from their modeling. This actually reduces AGL Energy's ((AGK)) profit estimate for FY15 by some 14%. Origin Energy's estimates have fallen too, but in smaller numbers.

The real benefits from rising margins, suggests the BA-ML analysis, won't be seen until FY16 and beyond.

Replacing Julia Gillard with Kevin Rudd has substantially improved Labor's chances at the upcoming federal elections, note strategists at CIMB Securities. They still maintain the Opposition holds the upper hand and a change in government should have a more positive impact for the local share market.

CIMB has singled out Qube Logistics ((QUB)) as the most likely clear beneficiary of a change in government this year. The company could benefit from a private sector development at Sydney's Moorebank intermodal freight terminal, point out the analysts.

Others could see marginal benefits, including BHP Billiton ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Qantas ((QAN)) from the coalition's plan to repeal the carbon tax if elected. In addition, Coca-Cola Amatil ((CCL)) may well benefit from any subsidy a new government might pay the food manufacturing industry.

Regardless of any Rudd-inspired miracles, CIMB analysts suggest the best possible outcome will be a clear majority winner at the ballot box, because a minority government hasn't really worked for Australia.

A high number of research reports were directed towards China this week, and not only because the interbank lending rate spiked higher, triggering worldwide concerns about a credit squeeze, or worse, in the world's second largest economy. As said earlier, forecasts for commodity prices are undergoing yet another wave of downgrades and those economists still holding on to GDP forecasts of 8% or higher for this year and next are quickly becoming a rare breed. Lower projections for China have been a drag on growth projections in general for Emerging Markets.

Finally, Citi's commodity analysts re-adjusted their longer term projections for China, trying to account for what is widely viewed as the necessary re-balancing towards a more consumption-oriented domestic Chinese economy. While such exercises are always full of simplistic inaccuracies, the end result nevertheless would have come as a shock to most China-watchers. Citi's calculations revealed copper consumption in China by 2020 could actually be up to 20-35% lower than consensus expectations while steel fares worse with up to 30-55% potential downside.

It was famous US baseball legend Yogi Berra who once said: "It's tough to make predictions, especially about the future."

He also said: "In theory there is no difference between theory and practice. In practice there is."
 

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article 3 months old

Trucking Yields For K&S Corp

- Earnings outlook stable, if a bit soft near term
- FY14 improvements expected
- Dividend yield of 7% to increase
- Plenty of valuation upside potential
 

By Andrew Nelson

After more than a two-year hiatus, analysts at Deutsche Bank have picked up coverage on K&S Corporation ((KSC)) again, but with a much more positive message and a Buy call this time around. The broker joins Macquarie, at Outperform, as being one of only two of Australia’s major broking houses to cover the stock.

In an analyst note yesterday, Deutsche Bank resumed coverage that was dropped back in February 2010. Back then the broker had a Hold call on the stock, split between a positive view based on fairly stable operations and the heat still being felt from the GFC. That dynamic has well and truly played out and two years later the broker is still positive, but has now left the pains of the GFC well behind it.

Let’s start with a refresher. K&S is a transportation and logistics company, or to put it more simply, it is a trucking company specialising in road freight in both Australia and New Zealand. The company also does some warehousing, distribution and more specialised fuel distribution work, as well as freight forwarding and a number of other activities that fit in the transport and distribution space.  

Back at the end of May the company announced FY13 net profit will likely be in line with FY12, but probably not better. At the time, only Macquarie was on the case and on the broker’s numbers the announcement pointed to an FY profit result of around. $16.4m. Macquarie was previously at $18.5m.

The broker cut its forecasts to bring them in line with the new guidance. FY13-15 EPS forecasts were lowered by 10.6%, 13.9% and 10.2%, which also pulled the price target lower. But given the shares had come off so much even at that point, the broker thought the bad news was already in the price. Add in the belief that a dividend lift was coming and the broker saw no reason to shift from Outperform.

Three weeks later we see Deutsche Bank picking up coverage, agreeing with Macquarie that the aggressive sell-off since the downgrade was simply too much. Sure, current conditions are difficult, but the business has always been a good cash generator and what’s better, much of that cash over the past year and a half has been put towards paying down debt. Gearing is now just 21%.

The broker thinks it won’t be too long before management is satisfied with the debt position and the drive to continue to repay debt will subside. What’s more, Deutsche Bank suspects we’re not far from that point. Once debt is comfortable, free cash flow will take off and the broker then expects to see the yield lift significantly in FY14 and then more in FY15. This will support a forecast dividend yield of over 7% out to FY15, believes Deutsche Bank.

The broker has also turned a little constructive on the backdrop, saying that with the cash rate likely to be trimmed further in the year ahead, there’s a good chance building, construction and manufacturing volumes could pick up in 2H14. Hence, higher volumes for K&S.

The broker hasn’t gone so far as to include this hoped for volume recovery into its forecasts, although it notes one thing is certain and that is transport volumes are always a leading economic indicator, thus K&S will reap the benefits well before the end markets it services.

On the broker’s numbers, the stock offers negative 10% or so EPS growth in FY14, but then 5% growth in FY15. On these earnings, the FY14 PE is 9.0x and FY15 is 8.6x and all on a dividend yield of 7%, which the broker thinks can only go up.

Macquarie’s numbers are much more favourable, the broker pencilling less than minus 1% EPS growth in FY14 and then 8.5% growth in FY15. PEs are 9.8x and 9.0x respectively on yields of 8.9% and 9.5%. What’s more, Macquarie thinks a hike in the dividend payout is still likely, thus the only thing missing is the minor levels of earnings growth it was previously expecting over the next 18 months.

Both brokers are within 10c of each other in terms of the price target. The FNArena database shows that the two brokers' averaged price targets offer more than 34% upside to yesterday’s close.
 

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article 3 months old

Treasure Chest: Qantas Set For Take Off?

- Domestic pricing pressures to ease
- International alliances to provide benefit
- Currency-based sell-off overdone


By Greg Peel

“We recognise,” said CIMB Securities this morning, “that investing in airlines is not for everyone given the industry’s volatility”. Another way to look at airlines is as stocks you “might wish to date but would not want to marry”.

In other words, airline stocks can throw up terrific shorter term trading opportunities but from the longer term investment point of view, they’ve long been considered by many to be a bet to nothing.

A case in point is the performance of the Qantas ((QAN)) share price in May. It has fallen from $1.90 at the beginning of the month to $1.52 on yesterday’s close, down 20%. The simple driver has been the sharply falling Aussie dollar. The long period of above-parity for the exchange rate has encouraged Australians to take their holidays offshore, which has boosted earnings for Qantas International. Now that the Aussie appears to be correcting, presumably that demand will dry up, and once again the Gold Coast will be popular.

So currency plays a big part in an airline’s performance. So too does the price of jet fuel, which is linked to the price of crude oil, given fuel is an airline’s most substantial running expense. The quandary here is that if the global economy is strong, more passengers will take to the skies, but then the price of oil will also be strong, offsetting the benefit.

Over a period of decades, airline ticket prices have suffered from extreme price deflation. When I was a uni student, I used to catch the train to Queensland. The cost of an air ticket was way beyond my means. Nowadays, a ticket to Queensland can cost about as much as one night at the pub. Air travel is no longer something one saves up for. Competition and aircraft efficiencies have ensured you can fly to Bali for a little more than tuppence.

A point I am yet to hear cited but which I personally feel must have an impact is that of internet technology, and particularly download speeds. Today one can sit in an office in Sydney and “meet” with a client or colleague in Melbourne or London over the net, face to face, as easily as if you were in the very same room. Emergency dash to Hong Kong on the red-eye? Not necessary.

All of the above adds up to airlines not being a great candidate for the longer term investment portfolio. That does not, however, suggest airline stock cannot throw up compelling trading opportunities every now and again. CIMB acknowledges the industry’s “volatility”, and volatility equals trading opportunity.

CIMB feels the big sell-off in Qantas shares this month on the back of the weaker Aussie is overdone. The broker has been forced to reassess its currency forecast input and has also taken note of rival Virgin Australia’s ((VAH)) recent admission that business in the second half FY13 has been tougher than expected, and as a result has reduced Qantas forecast earnings by 47% in FY13 and 17% in FY14. But the broker feels the market is discounting the fact that while a lower Aussie may stymie outbound international travel, it should re-encourage inbound demand.

Unfortunately a lower Aussie increases the cost of US dollar-denominated fuel, albeit the airline does hedge its fuel costs, but fuel prices are actually down 11% since February, CIMB notes. Currency considerations aside, CIMB is expecting “material” earnings growth for Qantas ahead driven by a more favourable domestic operating environment and improvements in the airline’s International business. The Emirates alliance will contribute to upside.

Citi had ceased covering Australian airlines a while back but the broker has now returned to the fold believing FY14 will be a “watershed year” for the industry.

Citi expects current aggression in domestic leisure pricing between Jetstar and Virgin to subside in the next couple of months. Qantas is the one playing aggressor, so it’s in the company’s interest. At the same time, Qantas’ aforementioned international alliances will begin to provide upside. Structural changes to the international network in particular should encourage further share price re-rating back to fair value, says Citi.

Virgin will also benefit from its alliances, Citi acknowledges, and the airline’s acquisition of Tiger offers further advantages. But it will take some time to integrate Tiger and passenger perception of the previously poorly thought of discount carrier will need to be improved. It will be a big call to juggle this integration alongside growing Virgin Australia further into the corporate space and together this leaves “little room for error,” Citi suggests.

Citi has re-initiated coverage on Qantas with a Buy rating and an expected total return over 12 months of 47% to the analysts’ target price of $2.30. Of the two airlines, Citi believes Qantas has the “clearer path” to earnings valuation and upside, and should resume paying dividends in FY14.

Citi has reinitiated coverage on Virgin with a Neutral rating with an expected total return of 3.4% to a target of 45c. Another issue facing Virgin and thus investors is the low free float level of listed shares, Citi notes.

The FNArena database now shows six Buy and two Hold or equivalent ratings on Qantas with a consensus target of $2.03, suggesting around 28% upside. Virgin attracts five Buy and three Hold ratings with a target of 47c for 8% upside.


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article 3 months old

Weekly Broker Wrap: Demand For Yield Persists

-Best opportunities for investors
-Capital returns most likely
-Diversification the key in picking E&C contractors
-Improving conditions for airlines
-Is the RBA being tardy in cutting the cash rate?
 

By Eva Brocklehurst

Demand for yield has dominated equity markets for most of the past two years. Interest rates are expected to remain low and Goldman Sachs expects investors will continue to reward companies returning capital against those that re-invest earnings. This should persist until there is more definite evidence of a recovery in growth. There is little room for further yield compression in the defensive, income-generating sectors as pay-outs are already high and, in some cases, dividend risks are mispriced in Goldman's view. The best opportunities are with companies that have conservatively managed their capital, despite the scope to increase cash returns. The broker believes the market response to the recent Woodside Petroleum ((WPL)) pay-out announcement suggests that short-term increases in returns to shareholders can be sufficient to drive a strong re-rating.

Cyclical industries dominate the list of stocks where cash returns are low, unsurprising given the recent earnings volatility. The broker's forecasts are for growth recovery in late 2013/early 2014 and this could see some names generate strong cash returns with accelerating earnings growth and rising pay-out ratios. Stocks that rank highest on Goldman's capital management scorecard include BlueScope ((BSL)), Lend Lease ((LLC)), Fairfax ((FXJ)), Beach Energy ((BPT)), Qantas ((QAN)), Origin Energy ((ORG)), Rio Tinto ((RIO)), Challenger Financial ((CGF)), Newcrest Mining ((NCM)) and JB Hi-FI ((JBH)).

On the other hand, many defensive stocks that have led the recent market rally are on the list of those for which pay-out ratios look stretched. Goldman worries about the valuation risk in many of these stocks as yields have compressed and dividends are potentially unsustainable. Companies are cautious and tactical capital returns, such as special dividends and buy-backs, are likely to be favoured over an increase to ordinary dividends. Goldman notes the market typically expects ordinary dividends to be a multi-year commitments. Moreover, the low borrowing costs with equity valuations at long-run average should make buy-backs earnings accretive for a high percentage of companies.

Goldman notes stocks with low levels of leverage include OZ Minerals ((OZL)), BlueScope, Downer EDI ((DOW)), Iluka Resources ((ILU)), Flight Centre ((FLT)), Wesfarmers ((WES)), Echo Entertainment ((EGP)), Cochlear ((COH)), PanAust ((PNA)), Carsales ((CRZ), Graincorp ((GNC)) and Lend Lease.

Goldman also asks the question as to whether the industry heavyweights will shift course. The broker attaches a low probability to the big miners significantly lifting pay-out ratios in the short-term, given the lack of visibility on commodity prices and a high level of maintenance capex. Debt-funded buy-backs are considered most likely because of the low leverage, heavily discounted UK listings and ability to lock in long-term funding at extremely low levels. Major banks may have room to lift pay-out ratios but the broker thinks special dividends are more likely, given uncertainty over capital standards and a soft credit environment. Commonwealth Bank ((CBA)) and Westpac ((WBC)) are best positioned for this.

The infrastructure and utilities sector has performed strongly in recent years and Goldman takes a backward-looking punt on picking winners, back-testing the predictive power of valuation metrics and financial data over FY00 to FY12. Among the lessons learned is that valuation-based stock selection works. Many of the metrics tested that generated positive returns achieved compound returns of over 10%. Another lesson is that selecting stocks based on distribution yield plus growth generated the strongest risk-adjusted performance.This strategy yielded compounded average returns of over 23% per annum for top quartile stocks.

Which stocks offer the highest current dividend yields in the infrastructure and utilities sector? Goldman notes Sydney Airport ((SYD)) and Spark Infrastructure ((SKI)). Those which offer the strongest forecast prospective dividend growth profiles are Spark, Australian Infrastructure ((AIX)) and Transurban ((TCL)).

For CIMB, a significant rise in costs is diminishing returns for asset owners in the engineering and contracting segment. Demand is not really the problem, as peaking activity has been well flagged and still remains well above historical levels. Rising costs will need to be shared or removed to ensure developments are viable. At best, CIMB thinks margins will be squeezed and those unable to assist clients in reducing costs will most likely be removed or replaced as a contractor. As an aside, the broker does not consider this is a specific problem for mining services but rather for all sectors.

For the contracting and engineering services, diversification by industry, geography and service should reduce economic impacts but won't entirely shield industry participants from the adverse effects of a downturn. A lot of earnings risk is already factored into share prices and attention should turn to emerging value. CIMB prefers companies which show diversity in international business, commodity type and service area. As a material improvement in Australian costs is unlikely in the near term, the broker urges caution across all Australian-focused engineering, construction, contracting, capital goods and other related service providers. Picking the bottom of the market will be difficult so the broker suggests an accumulation strategy. Preference is maintained for companies such as WorleyParsons ((WOR)), Ausenco ((AAX)), ALS ((ALQ)), Cardno ((CDD)), and Clough ((CLO)) for oil & gas exposure.

Traffic statistics from the airlines show domestic market capacity only grew by 3% in March. This means improving capacity restraint, according to UBS. Daily production of available seats has also consistently fallen on a sequential basis over the last six months. UBS thinks it is increasingly likely that Qantas and Virgin Australia ((VAH)) will cut the 5-7% capacity growth forecast for the June half year and generate positive yield in the June quarter. The broker notes that every 1% extra domestic unit revenue equates to $80m per annum extra pre-tax earnings for Qantas and $30m for Virgin. Jet fuel (Singapore benchmark in AUD) has dropped $15/bbl to $115/bbl since both companies reported in mid February. The broker thinks both airlines will benefit form improving operating conditions in the domestic market and easing fuel costs. Qantas remains the preferred pick on valuation and near-term momentum.

Macquarie took a look at reasons behind why the Reserve Bank of Australia has been reluctant to cut rates in recent years. Maybe the central bank wants Australians to save more and encourage firms to address weak productivity growth. The analysts believe this is desirable, and perhaps inevitable, but it's a painful process nonetheless. Household spending is not expected to resume the growth it enjoyed in the 1990s for some time yet. Macquarie takes a look at what Germany went through earlier this century. It took about five years for the benefits of the German reform process to outweigh the costs imposed. Monetary policy was not the key driver of the reforms either, but it did play a role in the background. The European Central Bank was reluctant to cut rates too far in 2002, creating an environment more conducive to reform, and then a spurt of rate cuts in 2003 helped offset some of the short-term negative effects. It meant reforms, when they were introduced, had a better chance of succeeding.

In the analysts' view the case for a cut to the RBA's cash rate in May is clear. Underlying inflation is running at the bottom of the 2-3% target band. The RBA expects growth to decelerate below trend over 2013 and for unemployment to rise further, which suggests that inflation will slow further from here. The strong currency continues to inflict pain on the tradeable goods sector of the economy. Despite that, markets are far from convinced of the likelihood of a May rate cut. If that's correct, and the central bank is keeping its powder dry, then there are some sobering implications for growth and the economy over the next couple of years, in Macquarie's view. When firms all focus on cutting costs to improve margins and profits it is likely to result in subdued growth, weak investment and rising unemployment. Where the economists differ from the RBA in characterising the situation for the year ahead is over the persistence of this softening in activity.

Returning to Germany, the ECB cut rates in two stages, initially cutting from 4.75% to 3.25%, waiting a year, then cutting again to 2%, leaving rates at a steady state then for a couple of years. Macquarie believes the ECB was channelling Germany's Bundesbank, which successfully dealt with a high inflation era 40 years ago. The RBA's original choice of the 2-3% inflation target was partly influenced by the success of the Bundesbank in keeping inflation in Germany around that level over the 1970s and 1980s. Also, Macquarie notes the RBA has consistently talked about the benefit of running growth (and inflation) a little weaker in the short term if it meant a more stable economy over the medium term.

High inflation is not a problem in Australia at present. Macquarie suggests that, once companies start cutting costs and improving efficiency, then the way in which monetary policy can assist that process is by preventing growth from falling too far. In Macquarie's view, action on the company side of the equation is now happening. This then suggests the RBA should become less reluctant to trim the cash rate.
 

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article 3 months old

Treasure Chest: Will Brambles De-Merge Recall?

- Brambles' core business steady
- Non-core Recall business is rife for a de-merger
- De-merged entities tend to outperform
 

By Greg Peel

When one thinks of Brambles ((BXB)), one thinks of CHEP pallets, both in Australia and the US. Brambles is fundamentally a supplier of reusable pallets and other crates and containers under the CHEP and IFCO brands for the purpose of transporting a wide range of goods. But also within the Brambles stable is the Recall business, which specialises in information service management, that is data storage, retrieval, digitisation and so forth.

While physical handling of goods and digital handling of information might have some parallels, Brambles pallet and Recall businesses are effectively stand-alone.

Last week Brambles provided a market update on its March quarter operating performance. Brokers found the results mostly “credible” and largely in line with expectations. The company boasted a 6% increase in pallet sales but the benefits were offset by weakness in other containers, and 5% fall in sales for Recall. JP Morgan summed up the mood by suggesting that lower Recall sales are not a major concern given the business is “non-core” compared to the core pallet business.

Management maintained its FY13 profit guidance, and Macquarie echoed the views of others by suggesting that despite challenges in some areas of the Brambles conglomerate, investors could look forward to reliable operating returns.  Macquarie is one of four brokers in the FNArena database with a Buy or equivalent rating on BXB, with two brokers on Hold. Valuation is an issue given a decent share price performance of late, which is cited by CIMB as the reason for the broker’s lone Sell rating.

The FNArena database shows a consensus price target of $9.02, which suggests 4% upside from the latest trading price.

UBS has a Neutral rating on Brambles.  In the wake of the company’s quarterly update, the analysts at UBS have decided a de-merger of the Recall business is looking increasingly likely in the near term. Taking forward earnings forecasts and debt levels into account, UBS suggests a valuation for Recall of $1.5bn. However the nature of Recall’s business, being 70% recurring revenues  storage fees and high cash flow generation, sets Recall up to be a likely “yield stock”, assuming attractive dividends alongside the defensiveness of recurring cash flows. Given just how hungry the market is for yield stocks at present, both in Australia and overseas, UBS suggests Recall could be valued by the market at better than $1.5bn, which would otherwise see the de-merged company enter the ASX 200 at around the 100 mark.

Recall’s only larger global peer is US-based Iron Mountain, UBS notes, but that company differs in being a more significant owner of property and running a much higher gearing ratio. Iron Mountain is effectively transforming into a REIT, which leaves Recall as arguably the largest information management service provider.

Brambles management could opt to simply sell off Recall to a willing buyer and use the funds to invest in more aggressive growth in its core business, but UBS does not expect this route to be taken. As it sits, the underlying business is comfortably providing funds for an elevated level of capex and a 60% payout ratio on dividends, the analysts note.

Hence UBS suggests an in specie distribution of Recall shares to existing Brambles shareholders is the most likely outcome. In specie de-mergers offer tax rollover relief and carry less execution risk than a trade sale or IPO, and cost less than a trade sale, although the analysts note around $15m would need to be spent to establish Recall as a corporation in its own right.

Should Brambles shareholders be excited by a Recall de-merger?

UBS has analysed nineteen Australian de-mergers executed since 1997 and found that on average the de-merged entity outperformed the market by 18% in the first year and 28% after two years. A relevant case study is offered by Orica’s mid-2010 de-merger of DuluxGroup. In the first twelve months, Orica and Dulux combined outperformed the market by 10%, and since mid-2011 Dulux has risen 70% to the market’s 10%.
 

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article 3 months old

The Case For Royal Wolf

- Market leading container position
- Broker sentiment positive
- Moelis sees further upside available


By Andrew Nelson

Royal Wolf ((RWH)) is a stock that has begun to garner increasing attention since listing in 2011. The company is a provider of portable container solutions in Australia and New Zealand, as well as providing bespoke international work. Container sales and leasing is the core business, with the company possessing the largest lease fleet in Australia.

Since listing on the ASX in May 2011, the company has been able to post steady revenue and earnings growth during a period of difficult economic conditions and slowing resources growth.

The stock boasts a positive read on the FNArena Sentiment indicator, with the FNArena Database showing two Buys and one Hold. Macquarie is the broker at Hold, having downgraded from Buy at the beginning of February. The broker thought the interim result was fairly solid, although largely in line with expectations. The problem for the broker at the time was that the share price was already pretty close to the analysts' revised price target.

Earnings estimates were lifted slightly, but there was also room for criticism. Macquarie analysts wondered, given an unfranked dividend, is it really necessary to maintain a 50% payout ratio at a time of increased investment in the fleet? That being said, Macquarie said it continues to like the company's potential on a medium-term horizon.

Credit Suisse, at Buy, likes Royal Wolf for its management quality, visibility and growing demand for its product base. The first half was strong, said CS back in February, and performance at that time was quite supportive of the broker's FY13 estimates.

Lastly, Deutsche Bank initiated coverage on Royal Wolf with a Buy call and $3.10 price target the same week. The broker thought the company was in a really good position to benefit from an Australian housing recovery given 20% of revenues are generated by the construction industry. Given the broker's forecasts for Royal Wolf are lower than other shares with Australian housing recovery exposure, the broker sees plenty of relative upside when the cycle does turn.

That takes us up to this week, when analysts at Moelis Australia initiated coverage with a Buy call of their own and a target price of $3.35. The broker’s target sits well above the $2.98 consensus target in the FNArena database.

Moelis likes the company’s diverse revenue base and operating footprint, noting RWH is not overly exposed to any single industry, but still well leveraged to any sort of broad-based economic recovery. The strategic market position is also attractive, the broker citing the fact that Royal Wolf is the largest supplier of container leases in Australia.

Importantly the company’s earnings are not overly exposed to any single industry or economic thematic, leaving plenty of scope for cyclical recovery upside.

The broker notes that in the past, sales were the primary focus. But in recent years, management has made some substantial progress in the container leasing business. This not only adds to the revenue base, but also improves earnings visibility given the typical leasing contact extends to 14 months. Yet the real point of difference is product innovation, Moelis citing a broad range of products that consistently help increase the viable usage of container units and thus demand.

It’s not the cheapest stock and there isn’t a lot of spare space on the balance sheet. Gearing is at 40% and this may well limit nearer-term opportunities for further bolt-on acquisitions. In fact, Royal Wolf currently trades at a 10% premium to domestic peers on FY14 earnings. Although, Moelis thinks the premium is appropriate given the company’s dominant market position.

Further complicating the valuation picture is the track record of strong performance delivered over the past year. Over the past twelve months, shares have outperformed the ASX200 index by 44%. Yet at a target price of $3.35, which is well above consensus, the company is still only trading on an FY14 PER of 15.0x. Reasonably priced, said Moelis, who suggests there is still upside available.
 

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article 3 months old

Weekly Broker Wrap: Europeans Home In On Oz Infrastructure

-Europeans target Aust Infrastructure
-Yield versus growth in infrastructure stocks
-Pressure on retailer margins continues
-General insurers, transport outperforms
-Who gains with media reform proposals?
 

By Eva Brocklehurst

Offshore competitors are circling. Citi has observed that European companies seeking growth are increasingly targeting Australian infrastructure projects. The broker lists Impregilo, Salini, Acciona, Bouygues, Balfour Beatty, Ansaldo and Obrascon as targeting Australian rail, road, water and power projects. The most exposed, overall, to this increased competition are Leighton Holdings ((LEI)) and Lend Lease ((LLC)). Citi believes Acciona's winning bid on Brisbane's $1.7bn Northern Link road project could be a test case for the Europeans' ability to undercut Australians on price and make a profit.

In resources, competition from international companies is greatest in LNG. Europeans have not actively targeted resource infrastructure projects to date, limiting involvement to mostly maintenance services. That could change. Citi finds the most exposed stocks in this respect are Monadelphous ((MND)), Downer EDI ((DOW)) and UGL ((UGL)). Orica ((ORI)) and Incitec Pivot ((IPL)) have enjoyed the mining boom mostly free from international competition but this too is expected to change. Citi notes the construction of the nitrates plant in Western Australia's Pilbara marks the first major investment in domestic ammonium nitrate production from an international producer, Norway-based Yara International. Orica is partnering with Yara and Apache.

Aurizon ((AZJ)) is BA-Merrill Lynch's top pick in the infrastructure sector, given balance sheet leverage and cost cutting potential. Asciano ((AIO)) will benefit from new grain and coal contracts and Transurban ((TCL)) will be driven by steady traffic and toll increases. TCL, AZJ and Qube Logistics ((QUB)) are considered to have the strongest 5-year compound annual growth rate.

The broker divides infrastructure companies into two broad camps. Companies such as Asciano and Sydney Airport ((SYD)) will show growth over the next three years as economic conditions improve, but these more cyclical stocks tend to offer a lower yield as capital is reinvested. On the flip side is DUET ((DUE)), Spark Infrastructure ((SKI)) and SP AusNet ((SPN)) which, being regulated utilities, have more defensive cash flow and offer higher yields. For example, on the FNArena database consensus forecast FY13 dividend yields are 6.8% for SPN, 6.6% for SKI and 7.5% for DUE. In contrast there's AIO (1.9%) and AZJ (2.4%). SYD appears to be the exception to the rule, showing a 6.9% yield. 

Some of these stocks, such as AIO, SYD and Australian Infrastructure ((AIX)) are more leveraged to GDP and the general economy. In contrast, the steady utilities such as DUE, SKI and SPN have more subdued growth profiles and exposure to the improved economic conditions. On Merrills' 5-year measure, QUB (14%), AZJ (10.5%), AIX (10.6%), TCL (10.3%) and AIO (8.85%) offer the strongest distribution growth. Although the regulated utilities currently have the highest yields in the sector, there appears to be little growth in distributions. The 5-year measure shows 3.3% for SKI, 2.9% for DUE and 1.5% for SPN.

Overlapping infrastructure for some stocks is transport and here Aurizon shines again for the broker. It is one of two notable structural turnarounds in the transport sector. The other is Qantas ((QAN)). Transport stocks outperformed the market in February, up a weighted average of 8.1% versus the ASX 200 at 5.4%. Asciano and Toll Holdings ((TOL)) were the key stocks for Merrills, up 15.7% and 17.7% respectively in the month. The broker puts the outperformance of TOL and AIO, as far as the financial results are concerned, largely down to margin expansion rather than top line growth and notes organic growth remains muted for each of Brambles ((BXB)) AIO, TOL and Virgin Australia ((VAH)).

There's been much talk about retailer margins. Citi finds Australian retailers seem reliant on gross margins to protect earnings. For FY13, most retailers are approaching record margin levels but the broker believes it can't last. Myer ((MYR)) and David Jones ((DJS)) are perhaps best placed to protect gross margins through greater private label sales and use of clearance outlets. Price discounting swings from season to season and, in Citi's view, the rise in FY13 gross margins reflects fewer discounts.

The other factor at play is price harmonisation, which can actually raise margin percentages but comes at the expense of sales growth. There are downside risks as new entrants and online shopping break down that margin advantage. Overseas retailers have responded to gross margin pressure in a range of ways such as private labels, clearance channels and service income. This is the sustainable path and where David Jones and Myer seem well positioned to leverage these gains. Other retailers may pursue the same opportunities but, in Citi's opinion, will only manage to offset natural margin pressure.

Credit Suisse notes general insurers have continued to outperform the market in recent months. They are now trading at a price/earnings premium to their five-year historical average. A slight premium is justified with the positive outlook continuing, albeit at a slowing pace. Despite QBE's share price being up significantly in recent months, it remains the broker's preferred pick in the sector. The broker supports the actions taken by QBE management and expects a continuation of underlying earnings improvement in coming years.

Insurance Australia ((IAG)) has recently widened the gap to Suncorp ((SUN)) on a price/earnings basis, a premium the broker considers appropriate. This is because IAG has most upside leverage to the local general insurance market and less downside risk from unpredictable natural peril events. Credit Suisse expects a slowdown in premium rate increases, a reduction in investment income and adjustment to new APRA capital requirements to play out for these stocks over the next one to two years.

This week new media reforms were proposed by the Commonwealth Government and, understandably, received a lot of press. Legislation is expected to be presented to the parliament within the next two weeks. The easy bit, and that which the Coalition is likely to approve, is a reduction in licence fees and mandating Australian content quotas. The Coalition intends to oppose a media advocate appointment, public interest test in relation to media mergers and a statutory press standards body. A parliamentary committee will be established to discuss potential abolition of the 75% audience reach rule while the Australian Communications and Media Authority (ACMA) will consider program supply agreements in determining control of free-to-air television. The Australian Law Reform Commission will to be asked to look at the possible implementation of a tort for invasion of privacy.

If a quick resolution is reached regarding the abolition of the reach rule, this will be added to the current package. Summarising the potential implications for the media, Credit Suisse notes a positive for Southern Cross Media ((SXL)) and Prime Media ((PRT)), which would both benefit from reduction in licence fees and the opportunity of abandoning the reach rule. Abandoning the audience reach rule would enable Ten Network ((TEN)) or Nine Network to take over SXL and Seven West Media ((SWM)) to take over Prime.

On the neutral fence is TEN and SWM, as the potential abolition of reach rules would be countered by the introduction of a public interest test, statutory press standards body and increased regulation of supply agreements. In Credit Suisse's wholly negative camp is News Corp ((NWS)), if a public interest test, press standards body and increased regulation of supply come about. Fairfax ((FXJ)) and APN News & Media ((APN)) are also in the negative camp because of the possibility of a public interest test and statutory press standards body.
 

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