Weekly Broker Wrap: Economy, Strategy, Technology, Banks, Fund Managers And Infant Formula

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-Time for contrarian stock picking?
-Morgans finds good returns from tech stocks
-Macquarie finds banks solid but uninspiring
-Demand for super advice continues to grow
-China relaxes on infant formula imports
 

By Eva Brocklehurst

Australian Outlook

Morgan Stanley expects a trough of 1.0% in the official cash rate in the first half of FY17 and considers the implications for domestic and rate-sensitive stock sectors are negative, on balance. This low cash rate is expected to assist the transition in the economy from the commodity super cycle. Housing is coming off a peak and the broker does not expect the recent commodity bounce to reverse the transition.

The broker believes Australia, like other developed markets, has passed the inflection point where easier monetary policy has a substantial positive impact. The next move lower in the cash rate, the broker suspects, will have the objective of containing risk but will be unlikely to turn momentum around in the short term.

Morgan Stanley introduces a score card on Australia in its transition and believes the country is much better placed than its OECD peers in terms of strengthening the financial system and demographic foundations.

The main sectors affected by the outlook include domestic-facing sectors such as banks, financial services, consumer stocks, builders and defensives. In domestic cyclical stocks the broker believes the causal links driving lower rates in most cases outweigh the stimulatory benefits that are typically seen.

For defensives, there should be valuation support and the stocks are expected to remain expensive. Hence, Morgan Stanley looks for relative value where possible. The one compelling theme is the global earners, on which the broker retains near double benchmark exposure.

New initiatives are required to fully unlock the fiscal catalyst in infrastructure identified for the likes of Lend Lease ((LLC)) but the broker's score card reaffirms support for global expansion, seen in terms of Goodman Group ((GMG)), Virtus Health ((VRT)) and Domino's Pizza ((DMP)). New export plays such as Treasury Wine Estates ((TWE)) and Mantra Group ((MTR)) are expected to benefit from the ongoing depreciation of the Australian dollar.

Strategy

May-June is typically the weakest season for Australian stocks, Morgans observes. The broker believes most stock pickers can use weakness to obtain preferred equities, particularly when that weakness is temporary.

Morgans screens its coverage for buy ideas heading into the end of financial year where tax loss selling may be overhanging prices. Both IPH ((IPH)) and RCG Corp ((RCG)), while recently issuing new equity at higher prices, have positive upcoming catalysts, in the broker's view.

Vitaco Holdings ((VIT)) is working through a period of trading below its IPO price while Whitehaven Coal ((WHC)), among the worst performers in the energy sector, Morgans observes, is now offering a solid risk/reward opportunity.

Some other contrarian ideas, where stocks are trading below valuation, include Wellard ((WLD)), MG Unit Trust ((MGC)) and Select Harvests ((SHV)), although these carry greater risk, Morgans warns.

Technology

Morgans believes tech stocks are hitting inflection points in terms of market share and the scale required to turn them into market leading entities from being just challengers.

The broker believe the consumption-based model, where consumers only pay for what they use, has just hit critical mass and the model is here to stay. This is a significant structural change to the industry and the broker believes those that invest wisely could make good returns from quality companies.

There are many with potential but the broker singles out NextDC ((NXT)) and Rhipe ((RHP)), retaining Add ratings for both. Morgans believes, with 12 months to go before build and fit out of NextDC's new locations in Brisbane and Melbourne, there is a possibility that cornerstone customers can be secured ahead of time.

These sites will have substantially lower operating costs, as sales and technical staff are already included in overheads and the company will own its land and premises. Rhipe, meanwhile, is generating positive cash flow while still investing heavily for growth.

The company revealed the margin impact from its top ten customers at the Morgans technology conference. This provided the more detail as to why its profit margins move around. If lower margin customers grow at a faster rate than higher margin customers then the blended margins come under pressure.

Banks

The current earnings growth profile appears increasingly uninspiring for the banks, Macquarie contends. Yet dividends should provide valuation support. The broker believes banks should be able to sustain elevated pay-out ratios, excluding National Australia Bank ((NAB)), as long as the balance sheet intensity is low. In this context, bank yields should underpin relative performance in a low rate environment.

The two areas of potential downside risk include the diminished profitability on deposit books and non-interest bearing liabilities. Macquarie's analysis suggests that margins will decline by 7-13 basis points over the next three years, based on current interest rate expectations, and Commonwealth Bank ((CBA)) will be most affected.

The other area is the growth in balance sheets. The broker reduces earnings estimates for 2016-18 by 2-3% as a result of expectations for slower volume growth, with the domestic retail banks being most affected. The broker retains a preference for ANZ Bank ((ANZ)) and Westpac ((WBC)), recently upgrading the latter to Outperform.

Fund Managers

Credit Suisse observes the funds management industry is maturing. Superannuation funds under management grew 13% per annum in the decade to 2005 and 9.0% per annum in the following decade. The broker now forecasts 6.0% growth in the decade to 2025.

Demand for advice continues to grow. The broker suspects that over the next decade the maturity of the system will mean an increase in demand from superannuants for financial advice and retirement products such as annuities. Both advisers and platform providers are expected to benefit from this phase.

Challenger ((CGF)) tops Credit Suisse's order of preference as it offers a unique exposure to the change in asset allocations, as superannuation shifts to the retirement phase from the accumulation phase. AMP ((AMP)) is second, as it offers upside through capital release from a life reinsurance deal.

Gateway Lifestyle

Shaw and Partners initiates coverage of Gateway Lifestyle ((GTY)) with a Buy rating and $2.91 target, attracted to earnings growth and cash generation potential. The company currently achieves earnings margins of 63% and 41% from rental income and developments respectively.

The main driver is the 4,157 sites that could be converted into tourist or permanent dwellings, assuming the company can maintain its average development profit of $107,000 per lot. As there are minimal maintenance capex requirements on established estates any future rental growth is expected to flow to the bottom line.

Infigen Energy

Shaw and Partners initiates coverage of Infigen Energy ((IFN)) with a Buy rating and $1.15 target, calculating a forecast total shareholder return of over 25%. The company has sold its US wind and solar assets and is now an Australian based renewable energy generator with 557MW of installed operating wind farms.

Given the support from the two major political parties for the large scale renewable energy target (LRET), and the forecast shortfall in renewable generation, the broker believes the renewable energy certificate price will remain above $80 for the medium term.

Given the widely held view that over 5,000MW of renewable generation needs to be constructed over the next five years to meet the LRET target, the broker believes demand for new projects is likely to be high. Infigen Energy is considered well placed to take advantage of the opportunity.

Infant Formula

China's requirement for certificates of inspection for imports such as infant formula has reportedly been relaxed until May 2017. UBS observes most participants in the industry are positive about the outlook for infant formula volume growth from offshore production. A higher birth rate is also expected to support the industry in 2016-17.

The broker is not aware of subsidies for infant formula being considered by the government at this stage. Mother & baby channels and online are taking market share in infant formula at the expense of supermarkets. UBS also notes scope for consolidation in the large format mother & baby stores in China.

Chinese labelling on infant formula imports in the eCommerce channel now appears likely to be enforced on January 1, 2018, versus the broker's prior expectations for November 2016.
 

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