Weekly Reports | Aug 08 2014
-Oz retailer growth via offshore sourcing
-Morgans adds Seek to high convictions
-Goldman adds Fonterra to mid cap focus
-Banks may remain expensive
-Better outlook for east coast grain
By Eva Brocklehurst
Australian retailers need new avenues for profit growth. This is the conclusion Citi has come to after analysing the sophistication of each major retailer's product sources. Wesfarmers ((WES)) is the most advanced in offshore sourcing. The broker estimates Myer ((MYR)), Specialty Fashion ((SFH)) and Super Retail ((SUL)) could achieve double digit earnings upside if they increase their offshore direct sources.
Retailers may lobby for lower wages but Citi contends they should focus on lower cost-of-goods sold (COGS). COGS represents at least 40% of costs and often up to 80%. Australian retailers over-rely on China and still use agents or wholesalers. Citi believe there is margin upside in expanding sources to include Indonesia, India, Bangladesh and Vietnam. In many categories a retailer can also cut out the middle man. Profit margins can be expanded in two ways, by increasing private label sales and increasing direct sourcing from overseas factories. Citi notes Myer and Super Retail have clear plans to expand offshore sources. The broker advisers that while there is margin upside, investors should be aware of the currency and inventory risks, which will of course rise with increased offshore sourcing.
Large cap stocks continue to dominate Morgans' high conviction list, which is returning an average annualised 35% return for positions sold in the last 12 months. The broker adds Seek ((SEK)) to this list as a preferred strategic exposure to disruptive technologies via the online services industry. The broker thinks the stock has potential to re-rate significantly after the August reporting season, given modest expectations for FY15.
Overall, the broker believes equities look fairly priced. The US market is trading around 8.0% ahead of fundamentals but Morgans considers this not uncommon during periods of economic recovery. That said, the broker warns that volumes and volatility are unusually low, which suggests markets are vulnerable to disappointment. The Australian market is finally growing after averaging an earnings contraction of 2% over the past four years. Morgans is confident the upswing will endure but thinks expectations for FY15 need to be tempered.
Goldman Sachs has added Fonterra Shareholders Fund ((FSF)) to its small & mid cap focus list. The broker's analysis suggests an extended period of surplus global milk production because of above-trend supply growth. This flows into lower New Zealand farm gate prices and higher margins for the company's ingredients and consumer brands. In July key performers in the list were FlexiGroup ((FXL)), Super Retail and Skilled ((SKE)), which delivered excess returns of 13.4%, 6.7% and 6.4% respectively. The key detractors on the list in July were Austbrokers ((AUB)), SG Fleet ((SGF)) and Alacer Gold ((AQG)), delivering negative returns of 12.2%, 6.9% and 6.9% respectively.
UBS expects another strong result from Commonwealth Bank ((CBA)) in FY14. Revenue growth is solid, costs are under control and asset quality is benign. The broker observes that over the last few results briefings, the bank has been at pains to illustrate the strength of its capital position. This is significant, as UBS suspects the Financial Systems Inquiry is likely to require banks to materially increase their CET-1 capital ratios to reduce taxpayer exposure to failure.
The broker expects Bendigo & Adelaide Bank ((BEN)) to deliver a 12% rise in FY14 cash profit. Although lending growth has been subdued, improving deposit pricing should underpin margin expansion. Overall, the broker believes the outlook for the banking sector remains robust and trends are positive. Valuations look stretched but given a benign outlook for interest rates, banks may remain expensive for some time. The FSI outcome, due in November, remains the biggest issue they face.
The Australian Bureau of Meteorology has downgraded the chance of an El Nino developing this summer to 50% from 70%. This is a positive development in Bell Potter's view for those stocks exposed to east coast grain volumes such as Ruralco ((RHL)) and Graincorp ((GNC)), as well as farming operations that have water as a cost, such as Select Harvests ((SHV)) and Webster ((WBA)). Pricing risk lies to the upside for Webster in the broker's opinion, as average US walnut export values are up 10% in the year to date. Webster is a counter-seasonal supplier and likely to benefit from higher export prices. Webster has rallied 27% from its recent low and plans to plant 900 hectares of new orchards over the next three years.
Live cattle export volumes are now up 65% year on year and this is a positive earnings driver for Ruralco. The southern hemisphere grape crush among top producers looks to be down 5-6% which is a positive for Australian Vintage ((AVG)), in the broker's analysis.
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