Weekly Reports | Mar 17 2017
Weekly Broker Wrap: Insurers and Youi; value in IP services; equity strategy: China outlook; and the issue of an east coast gas shortfall.
-Domestic majors deliver better GWP outcomes in first half versus Youi
-IP services companies seen offering compelling value
-Deutsche Bank moves to overweight on banks and miners
-Solid outlook in China, Improved seasonal demand expected
-Could a national oil company work for Australia?
By Eva Brocklehurst
UBS has taken a close look at Youi's first half result, the fastest growing and most visible challenger brand in the insurance sector to date. On the broker's estimates, gross written premium (GWP) only grew by 0.5% and, for the first time since Youi commenced operations in 2009, the domestic majors actually delivered better outcomes.
UBS does not believe other challenger brands have slowed to the same degree and Youi's brand proposition remains intact. Nevertheless, Insurance Australia Group ((IAG)) and Suncorp ((SUN)) are expected to face an easier operating environment over the medium term.
Macquarie believes Youi is still growing faster than the market, noting the first half results follow a poor result in the prior half for GWP. The company is also, as noted, addressing a couple of specific issues such as customer confidence in its brand and distribution constraints. While slower churn in the market is a headwind for challenger brands the company believes this will abate.
A lack of natural catastrophe events have resulted in a soft pricing environment and consumers are not shopping around for lower premiums. Macquarie believes the major challenger brands will continue to increase their market share and impact on the overall profitability of the incumbents.
UBS believes the worst of the cyclical margin squeeze since FY14/15 is now behind the sector. As in the past, the broker suspects recovery is likely to be underestimated. Commercial profitability is turning around earlier than expected. Suncorp's personal lines are running better than previously believed although New Zealand could become worse before it gets better.
Personal lines margins are expected to stabilise in the industry, if not rise in 2017, as insurers respond to claims inflation with containment measures. The broker believes there is a case to own all the insurers but retains a preference for Suncorp (Buy) over IAG (Neutral).
Bell Potter believes intellectual property services offer compelling value and are now trading materially below the market. The three companies IPH Ltd ((IPH)), QANTM IP ((QIP)) and Xenith IP ((XIP)), which form the ASX listed sector, are all trading at a discount to market price/earnings for FY17 to the tune of -1%, -11% and -27% respectively. While agreeing with the relative ratio ranking between the three, the broker believes the sector as a whole is materially undervalued.
The broker accepts there was merit for a de-rating of the sector, given stretched valuations a year ago. Yet, more recently the sector experienced a further downgrade with a number of company-specific issues weighing, such as IPH's slower growth in Asia, seasonality in regard to QANTM and investment by Xenith to support integration.
Bell Potter believes this is an attractive buying opportunity and prefers QANTM and IPH. Core fundamentals that are underpinning a positive outlook include diverse clients, relatively high revenue visibility, minimal work-in-progress, 90-100% cash flow conversion and solid balance sheets.
Global equities may be vulnerable to a dip, Deutsche Bank suggests. The broker notes it has been a long time since the S&P500 dropped much and the US Federal Reserve rate hikes pose a risk. Beyond a dip, Australian equities appear well positioned. Earnings continue to be upgraded and the average price/earnings ratio of around 16 remains in line with the fair value model.
The main concern is that share prices of major miners may struggle when the iron ore price eventually falls, although the broker's analysis suggests the relevant stocks have already priced in a fall and share prices look low relative to firm Chinese growth.
Deutsche Bank moves to overweight on banks as well and asks the question whether it can work to be positioned in both of these heavyweight sectors. The answer is, yes, as it is not all that rare for both sectors to outperform and valuations are low versus the industrials.
The broker has cut back exposure to yield stocks as they have been in a holding pattern in recent months and now look vulnerable with Fed rate hikes finally on the way. Meanwhile, value stocks are attractive, with financials in this bracket.
Domestic conditions appear soft as, while nominal GDP growth is back to average, it is lacklustre relative to the move in commodity prices. The broker observes miners are not sharing the gains around, with revenues being up but expenditure on capital investment and other costs at a decade low. Meanwhile, the consumers spending impulse has softened. The housing cycle is still rolling on and this should benefit select stocks.
Returning from China, Macquarie suggests further price gains for most bulk commodities are very unlikely. Demand conditions have been slightly disappointing post the Chinese New Year, although most observers maintain constructive expectations. Near-term demand weakness is being blamed on the central government meeting and ongoing environmental controls that are affecting many industries. Hence, many are hoping for an improvement in the second quarter via the usual seasonal trends.
In terms of macro demand, concerns over inflationary pressures appear to have eased and the economy is expected to be well supported by infrastructure spending ahead of the political reshuffle in October. Property sales are strong and the measures to cool the property market appears of affected only the most overheated tier 1 and tier 2 cities.
Downstream sectors such as automobile manufacturers expect sales to rise 5% this year, down from more than 13% growth in 2016, of which new-energy car sales are expected to increase to 800,000 units from 500,000 units last year.
Copper demand appears positive as cable manufacturers are buoyant, driven in particular by the demand for property. Nevertheless, on the supply side copper is plentiful and the physical market indicators imply the market is not tight. Macquarie believes Chinese copper supply is likely to be sufficient to meet demand.
The broker found aluminium interesting, with regard to ongoing uncertainty about proposals to cut smelter output in 28 northern cities over the winter to control pollution. Aluminium consultants estimate the lost primary aluminium output may only be around 1.1m tonnes and at least half of this could be made up by building up inventories ahead of closures, or smelters elsewhere increasing output.
Macquarie observes, in actual fact, aluminium ingot inventory has risen quickly in China, reaching more than 1m tonnes in March.
East Coast Gas
Solutions to Australia's east coast gas shortage, which has reared into the spotlight recently, could take several paths, Credit Suisse contends. Third-party gas going through Curtis Island, largely from GLNG, could be diverted to the domestic market where needed. LNG could also be imported, or the government could do nothing and watch manufacturing in Australia rapidly disappear (an issue which the broker does not wish to contemplate).
The fourth path, the broker considers, is whether a national oil company, such as Kumul Petroleum in PNG, would work. Here the national oil and gas company participates in the project itself in the absence of a super profits tax. Instead of Australia's PRRT (petroleum resource rent tax) on future projects, could there could there be some form of state participation?
In a perfect model the fiscal take is exactly the same, but state participation has a number of benefits for the challenges faced today. These include internal rates of return being higher because of a lower tax take, and therefore easier to get by board rooms.
The government entity would also be able to have its equity entitlement of gas, effectively reserving if needed without mandating a reservation policy. Another supportive factor is that private sector funding requirements would be lower, potentially involving the government's ability to obtain concessional financing for key projects.
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