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Weekly Broker Wrap: Earnings Season May Disappoint

Weekly Reports | Feb 04 2013

-Upcoming earnings season uncertain
-Risk with over-optimistic expectations
-Earnings downgrades outweigh upgrades
-Talk of Crown/Echo merger to continue

By Eva Brocklehurst

Know your stocks. The upcoming reporting season is full of uncertainties, according to JP Morgan, perhaps more so than the last. The broker sees potential for just 23% to surprise with better performances, which is close but below the long-term average, and 35% likely to offer downside surprises, again slightly below. A few stocks have excess cash, which may hold out prospect of increased dividend or a stock buy-back, and some are struggling to generate cash flow in the current market. For Credit Suisse, the greatest area of concern is domestic cyclicals as these have seen a re-rating in recent months despite an underlying deteriorating domestic growth profile. Credit Suisse prefers bond proxies such as the Australian real estate investment trusts (REIT), infrastructure and utilities sectors as well as defensive industrials and global industrials. This broker is underweight banks, domestic cyclicals and mining services.

So which are those JP Morgan thinks have excess capital and could launch a new buy-back? Ainsworth ((AGI)), Amcor ((AMC)), Australian Pipeline ((APA)), Aurizon ((AZJ)), BHP Billiton ((BHP)), Challenger ((CGF)), Coca-Cola Amatil ((CCL)) Domino's Pizza ((DMP)), Flight Centre ((FLT)), Nib Holdings ((NHF)), REA ((REA)), Rio Tinto ((RIO)) and Sims Metal ((SGM)).

Some the broker thinks may need to raise additional equity include Alumina ((AWC)), APN News ((APN)), BlueScope ((BSL)), Oil Search ((OSH)), Crown ((CWN)), Goodman Fielder ((GFF)), Leighton ((LEI)), Lynas ((LYC)), Ramsay Health ((RHC)), Paladin ((PDN)), Southern Cross Media ((SXL)) and Seven West Media ((SWM)).

For UBS, Australian corporates face earnings headwinds, even though the market has rallied in the last six months amid improvements in the global economy. Some important drivers of earnings growth have turned up in recent months, according to this broker. Commodity prices have bounced from September's lows, creating upside for mining sector earnings. As well, the rally in the stock market bodes well for those stocks leveraged to the market, even if fund flow is still not super strong. Nevertheless, the broker sees this reporting season as likely to be a "hand brake"on the rally rather than an "accelerator". 

What are those companies UBS sees offering potential upside surprise? On a quantitative view basis, some with potential upside are Beach Energy ((BPT)), Mirvac ((MGR)), Primary Health ((PRY)), Sonic Health ((SHL)), Tabcorp ((TAH)), Tatts (TTS)). Downside? These are Commonwealth Bank ((CBA)), Goodman Group ((GMG)), Leighton, and Lend Lease ((LLC)). On a fundamental view basis, those that could surprise on the upside are Automotive Holdings ((AHE)), GPT ((GPT)), Insurance Australia ((IAG)), Monadelphous ((MND)), Myer ((MYR)), Super Retail, ((SUL)), Pacific Brands ((PBG)) and Toll ((TOL)). Downside? These could be Bradken ((BKN)), Brambles ((BXB)), Computershare ((CPU)), David Jones ((DJS)), QBE ((QBE)), Santos ((STO)), Stockland ((SGP)) and SMS Management ((SMX)).

Credit Suisse sees significant earnings risk across some sectors because of overly optimistic market expectations and a weak domestic macro environment. Since the last reporting season the broker has reviewed trading updates and production reports for ASX200 stocks and has noted few earnings upgrades. However, earnings downgrades are occurring in cyclical sectors such as metals, mining and industrials. Credit Suisse has identified 21 downgrades, including equity raisings, across its ASX200 coverage up to January 16 2013.

CIMB also warns that over-optimistic expectations often disappoint. Here, the analysts have developed models which find that a positive bias in forecasts is an indication that negative information may be missing from the consensus. The model suggests accelerating and intense short selling in the lead up is a good predictor of earnings disappointment. So, what are likely nasty surprises out there. CIMB notes stocks which have the highest likelihood of disappointing expectations include Sandfire ((SFR)), Sims Metal, Kingsgate Consolidated ((KCN)), Cochlear ((COH)), Western Areas ((WSA)), Coalspur Mines ((CPL)), Virgin Australia ((VAH)), Saracen Mineral ((SAR)), Whitehaven Coal ((WHC)), Beadell Resources ((BDR)), Medusa Mining ((MML)), Buru Energy ((BRU)), The Reject Shop ((TRS)), Ten Network ((TEN)), Arrium ((ARI)), Iluka ((ILU)), M2 Telecom ((MTU)), Perseus Mining ((PRU)), Leighton, St Barbara ((SBM)) and Fairfax ((FXJ)).

Looking more closely at gambling stocks, Goldman Sachs finds that completion of refurbishing at Crown Melbourne, Crown Perth and The Star will drive earnings growth. The broker expects talk of a Crown ((CWN))/Echo ((EGP)) merger will continue this year, given that the share price ratio of the two is the highest it has been since Echo listed. Despite the fact that a takeover of Echo would be earnings dilutive for Crown, the broker recommends Crown as a Buy based on strong earnings growth and a positive view of Macau. The broker has company. On FNArena's database there are seven Buy ratings and one Hold. Echo is a bit more mixed with two Sell, two Buy and four Hold.

Goldman Sachs also finds Sky City ((SKC)) a Buy, with earnings upside seen from the Adelaide casino redevelopment and the NZ National Convention Centre. However, Tabcorp has drawn a Sell recommendation. Goldman cites flat earnings and high debt. BA-ML also has it as a Sell on the FNArena database. There are five others with Hold ratings and two with Buy ratings. Tatts is a Hold for Goldman Sachs, although the online lottery may gain traction and present upside risk, while Aristocrat ((ALL)) is Hold based on a benign US outlook. Citi also recently confirmed Aristocrat as a Hold recommendation on the FNArena database. The stock has four Hold, three Buy and one Sell (BA-ML). BA-ML remains cautious on the trading outlook, despite 2012 earnings beating its estimates. Tatts has a mixed review on the database with four Hold three Sell and one Buy. In this case BA-ML is the odd one out again. Here, the broker sees higher earnings coming on the back of the purchase of the South Australian lotteries and keno licences. 

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