Weekly Broker Wrap: Outlook, Banks And Strategies

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-Significant AUD weakness unlikely
-Buying cheap banks no longer works
-Market fully valued, stock picking reigns
-CityLink early reversion unlikely
 

By Eva Brocklehurst

Outlook

Macquarie has updated its outlook following the Brexit decision and the Australian election. The broker previously expected a decline in the Australian dollar, in keeping with the divergence in global monetary policy expected throughout 2016.

Now, with a diminished outlook for divergence, the prospects for a lower Australian dollar have weakened. The broker is of the view that the Reserve Bank will need to cut official rates further, dragged down by a deflationary outlook. Nonetheless, with easing elsewhere these cuts are unlikely to deliver significant weakness.

Macquarie has also upgraded population growth forecasts, suspecting that with a weaker outlook and employment prospects in the UK, a major ex pat destination, more Australians could return or stay put at home.

The broker's 2016 GDP growth forecast is upgraded to 2.5% from 2.2%, while 2017 is trimmed to 2.0% from 2.5%. Macquarie expects the economy will struggle to grow fast enough to absorb spare capacity and generate inflation.

Banks

Macquarie's analysis of retail buying activity suggests retail investors in the banks held their positions in the June quarter, after being net buyers in the first quarter. The broker notes ANZ Bank's ((ANZ)) share price performed relatively well following the reduction in the dividend, but retail investors did reduce positions following the decision.

Hence, the broker suspects National Australia Bank's ((NAB)) position is vulnerable, should it also cut the dividend. The recent reduction in the level of short interest and ongoing net buying from retail investors, underpins the broker's view.

Deutsche Bank contends that buying the cheapest major bank is no longer working as a strategy, with its analysis suggesting that since the GFC this strategy has underperformed the banks index and buying the higher price/earnings ratio actually delivered better compound growth.

The broker has tested a number of trading strategies and finds that holding the worst performing major each quarter has delivered the greatest outperformance. Buying the least favoured bank based on consensus sell side stock ratings also proved successful.

The worst strategies that were tested were buying the highest yielding bank or best performing bank.

Meanwhile, the Reserve Bank of New Zealand has released a consultation paper proposing changes to the loan-to-value (LVR) restrictions on banks, aimed at further mitigating risks to financial stability from the boom in NZ house prices.

The proposals include no more than 5% of lending to residential property investors at a LVR over 60% and no more than 10% of lending to owner occupiers at LVR over 80%. The RBNZ estimates the new proposals could reduce both house prices and mortgage credit by 2-5%.

Deutsche Bank considers it unlikely the Reserve Bank of Australia will follow suit in the near term, given the NZ housing market is being affected by unique factors. Australian house price growth appears to be moderating as is investor activity. The broker takes the RBA's latest statement to signal there are few imminent concerns regarding the Australian housing market.

Market Strategy

Shaw and Partners seeks out stocks that appear good value and those that do not, based on market expectations, given its favourite measure of value – total shareholder return derived from consensus targets and dividend estimates – is flashing “amber”.

The index suggests a fully valued market but those stocks that appear good value from a risk/return perspective to Shaw include Macquarie Group ((MQG)), Lend Lease ((LLC)) Qantas ((QAN)), National Australia Bank, Vocus Communications ((VOC)), IOOF ((IFL)) and Flight Centre ((FLT)) among the large cap stocks.

Mining stocks, particularly Fortescue Metals ((FMG)) and Newcrest Mining ((NCM)) appear over-priced, but the broker suggests many analysts are using overly bearish or out-of-date commodity price assumptions.

The broker is witnessing a significant upward revision to energy, materials and the real estate investment trust sector earnings with downgrades elsewhere. With relatively large weightings for these sectors the broker observes this is enough to propel market aggregates higher.

That said, the market appears unconvinced about the outlook for economic growth so the rally is based on declining risk premia more than anything else, Shaw maintains.

Transurban

CityLink is Transurban's ((TCL)) most important toll road concession, reflecting 18% of RBC Capital Markets' discounted cash flow valuation, hence the interest in speculation about early reversion. The broker believes there is a low probability the concession will make the necessary returns and the concession be terminated early.

The concession ends in 2035 but can revert as early as 2025, if a certain return threshold is achieved. The broker's base case is for CityLink to achieve a real equity internal rate of return of 15.6% in 2025 but only 0.1% higher by 2035, given the impact of certain taxes that are payable as well as capacity and debt repayments.

The broker acknowledges the concession is complex and may be open to interpretation, while the treatment of debt and capex is unclear. Yet the shortcomings of the analysis do little to alter the broker's conclusion.

Infomedia

Infomedia ((IFM)) provides software to the parts and service sector of the global automotive industry as well as data analysis and research. Around 80% of its revenue is generated outside of Australia in 186 countries.

The mature product, Microcat, is used by a large number of customers and generates around 75% of revenue while the burgeoning product, Superservice, is gaining traction and generates around 20% of revenue.

Bell Potter expects continued modest growth in Microcat and strong growth potential in Superservice and initiates coverage on the stock with a Buy rating and 75c target. The broker notes a number of key executive changes over the past few years, with the latest update to the market and FY16 guidance suggesting a refreshing of strategies and a more stable outlook.
 

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