Weekly Reports | Aug 01 2014
-Russia ups gold purchases
-NAB likely to adopt IFRS 9 early
-AVG sells Yaldara, ELD sells Charlton
-Aussies increasingly heading overseas
-PRY becomes VRT competitor
-Costs a headwind for retailers
By Eva Brocklehurst
Central banks were buyers of gold in the first half of 2014. Macquarie notes sellers were few and far between. Three countries – Russia, Iraq and Kazakhstan – accounted for most of the purchases. Central banks and international financial institutions, as well as sovereign wealth funds, have historically been the most important holders of gold. Those that report to the International Monetary Fund reported holdings of just over 29,000 tonnes of gold as of June 2014. This understates total holdings as it does not count the gold held by some central banks which do not report, nor any gold held by sovereign wealth funds.
Why is this important to know? Annual flows in and out of the central banks are relatively small given their holdings, but can have a big impact on the gold market and the price. Extrapolating the purchases forward to the second half of the year, Macquarie estimates total net purchases of 226 tonnes, higher than 2013 but below 2012. The shift to higher purchases this year is largely Russian inspired and given that country's FX reserves have fallen, Macquarie suspects this might reflect a preference for gold over government bonds in the current political environment. The fact that gold has managed to rise in price this year should calm some nerves about its long-term outlook, in the broker's view.
The new IFRS 9 provisioning standard for bank credit reporting is now on the table. This will come into effect on January 1, 2018. The most important aspect is a move to an expected loss-provisioning model from an incurred loss-provisioning model that is currently in place. This will, in turn, require more timely recognition of credit losses and early adoption of the new standard is permitted. JP Morgan expects annual provisioning charges will rise with a deteriorating credit environment, as opposed to banks building buffers in so-called good times.
The broker expects National Australia Bank ((NAB)) will be the most likely of the big four to adopt this provision early, as it has $550m in its general reserve for credit losses, versus major bank peer average of $170m. A move to IFRS 9 accounting by the major banks in the long run may result in early recognition of credit losses, but may not assist with smoothing out volatility in bad debt charges. Beyond expecting that NAB may be an early adopter of this accounting practice, the broker believes there are limited implications for sector valuations.
In agricultural news, Australian Vintage ((AVG)) has announced the sale of the Yaldara winery and brand for $15.5m, while also executing a two-year processing agreement for its Barossa grapes. On face value the transaction is around 5% earnings accretive on an annualised FY15 basis, in Bell Potter's view. Meanwhile, Elders ((ELD)) has announced the sale of the Charlton feedlot for $10.1m which will provide a handy profit of $4m. A positive for the rural sector is that export markets for live cattle remain strong, with mid year reports indicating the number of head for 2013/14 is up 25% and export volume expectations for 2014/15 have been raised 11.4%.
Bell Potter has examined how holiday travel expenditure and disposable income is shaping up after the federal budget knocked consumer confidence earlier this year. Holiday travel expenditure, including domestic and outbound, as a percentage of disposable income has been virtually unchanged at around 6.5% over the past eight years. This is consistent with the broker's view that Australians are prepared to spend money on a holiday regardless of circumstances. There is a clear shift in the numbers towards outbound travel and away from domestic – outbound has tripled the growth in domestic expenditure over the same timeframe – and the broker expects this trend to continue. In periods of material economic disruption outbound travel tends to slow. Bell Potter notes this impact tends to be transitory and periods of weakness are followed by a strong recovery.
The implications for stocks in the sector means the trends are positive for Cover-More ((CVO)). Cover-More remains the purest way to play the outbound travel theme in Bell Potter's view. Flight Centre ((FLT)) is also a likely positive beneficiary of any recovery in the household sector, given the sale of outbound travel remains the single largest driver of earnings. The trend shift from domestic has negative implications for Webjet ((WEB)),Virgin Australia ((VAH)) and Wotif.com ((WTF)). The latter has been a major loser in the shift to outbound travel at the expense of domestic.
Primary Health Care ((PRY)) has debuted as a provider of IVF services, opening a clinic in Sydney and offering bulk billing. The offer of bulk billing should be able grow the market, given lower economic quartiles are under-penetrated because of the cost of the service. The model is in its early stages and UBS makes no adjustments to forecasts but, since a referral to an IVF specialist ultimately comes via a GP, believes Primary will have an opportunity to capture referrals from its own clinics in NSW. A risk for established IVF providers is that Primary-owned GP clinic referrals could now go "internal". At present the risk is contained to less than 2% for IVF competitor Virtus Health ((VRT)) volumes as Primary's GP base is concentrated in NSW.
BA-Merrill Lynch expects fixed cost increases will continue to be an obstacle for discretionary retailers. In the past three years, earnings for this group have declined by 21% and the key driver of the decline was fixed cost growth. The broker expects fixed cost growth to moderate slightly in FY15 but still impose a 3.2% headwind. Margins also risk coming under severe pressure. The broker expects discretionary retailers will be dealing with Australian dollar buying rates that will be up to 10% below FY14 levels and this will put upward pressure on pricing. Price rises could be hard to pass through if sales are subdued. Even if gross margins remain flat, retailers will not enjoy the earnings benefit from gross margin expansion that they have sustained in recent years.
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