Weekly Reports | Aug 14 2015
-Macquarie calls for Port Kemba closure
-Netflix brand awareness and traction high
-Insurer premiums under pressure
-Reward for small miners with visibility
-Majority of mine job losses still to come
-Weaker renminbi, weaker AUD likely
By Eva Brocklehurst
Supply and demand dynamics in the steel sector are weak. There are further challenges, in Macquarie's view, as it becomes evident that China, expected to curtail supply as consolidation and environmental clean-ups occurred, instead appears intent on capitalising a cost advantage and increasing its exports.
Hence, the need for BlueScope ((BSL)) to act is becoming clearer by the day to the broker. Macro conditions are unlikely to support holding out for better fundamentals. Closing Port Kembla steel making could add $2.20 to mid cycle valuations and the current price discounts little of this potential, in the broker's view. Macquarie upgrades the stock to Outperform and raises the target to $4.70.
Paying For TV
Citi has taken a grip on the reality of streaming video on demand (SVOD), examining the landscape using an external survey to gauge sentiment towards paid content in Australia. The research reveals brand awareness for Netflix is as high as it is for Foxtel and the penetration of Netflix is five times that of the next closest players, Stan and Presto.
Retention rates encourage the view that consumer interest is strong. Netflix boasts the highest rate of those considering SVOD as well as conversion to paying users. It appears to the broker that years of free publicity have worked. Foxtel remains the key provider of premium sports and drama for PayTV platforms, expected to reach 35% penetration by 2018.
For free-to-air broadcasters the increasing penetration of SVOD is expected to place further downward pressure on audiences and likely limit earnings growth, with Citi believing operators need to focus on differentiating their content.
Macquarie cites the Marsh Review of the Australian general insurance market, which suggests insurers are becoming concerned about sustainability in the pools covering significant claims. Continued pressure is expected on commercial premium rates.
Prior to the first half of this year, Australia was below the 10-year average for first half natural disaster losses for three consecutive years. This was crucial to current profitability and favourable market conditions for buyers.
Marsh identified mergers and acquisitions as being necessary to maintain returns. The expected rise US interest rates will not, initially, impact on market capacity, the survey suggests, but the fall in the Australian dollar remains a hindrance to the local market and contributes to more aggressive competition and downward pressure on premium rates.
Marsh also notes the inclusion of New Zealand risks in Australian master policies is resurfacing after the market moved to separate such risks following the Christchurch earthquakes.
Small Cap Miners
Is it over for small cap resources? Morgans does not believe this is the case. Solid performances from a number of small quality operators are evident. The broker believes investors are rewarding those companies which demonstrate some visibility on the path to production. An example is Atherton Resources ((ATE)), which aims to be in production by the end of 2016, and which has almost doubled in price since May.
Another is Dacian Gold ((DCN)) which has risen 20% this month after it released a resource estimate for its Mt Morgans project, with production scheduled in 18 months. Metro Mining ((MMI)) has also doubled since March and aims to start up next year. Two others are Highlands Pacific ((HIG)), which has run up 50%, and Geopacific Resources ((GPR)), which is up 35%.
Based on current indicators, Australia appears to be 30% through the mining capex decline, Commonwealth Bank analysts maintain. The remainder of the downturn in mining investment will not only detract from GDP but also the labour market. To date the analysts note job gains in residential construction and parts of the services industry have more than offset the mining-related job losses.
One of the offsets to resource construction jobs is the rise in production and extraction employment as the operational stages of the mining cycle pick up. However, this stage requires fewer jobs than in construction. The analysts cite Reserve Bank research which indicates the ratio of construction to operations in terms of the workforce is 2-3:1 for coal and iron ore mines and 10:1 for WA LNG projects. The analysts calculate this reduces to 5:1 for Queensland LNG projects.
The analysts calculate that Australia is 20% through the decline in mining construction jobs. They also believe the RBA forecast for operational mining employment to rise by 30,000 over 2013-2018 could be optimistic, given recent declines in commodity prices.
The outlook for office markets suggests vacancy rates are gradually improving in Sydney and Melbourne, where demand is recovering. Credit Suisse observes these markets achieved the strongest effective rent growth and capital value uplift over the past 12 months.
In contrast, in Brisbane and Perth Credit Suisse forecasts negative rent reversions and near-term peak vacancy rates of 20% and 24% respectively. Credit Suisse suspects, for assets with income risk in these two cities, valuations could fall further as rents are affected by new supply and push up vacancy levels. Mirvac ((MGR)) remains the broker's preferred exposure in the office segment.
Chinese authorities have devalued the renminbi by 3.5% against the US dollar over the past three days and there may be more to come. This is the country's largest devaluation in two decades. Credit Suisse expects the weaker currency to place upward pressure on the US dollar and be another source of global deflation.
Further Chinese devaluation will result in a weaker Australian dollar – Credit Suisse has cut its forecast to US68c in 12 months – and raises the risk of more RBA cash rate cuts. It also may bring forward Chinese investor demand for local housing, Credit Suisse suspects.
Beneficiaries of a weaker renminbi include those companies exposed to the dividend trade, international earnings and with a large proportion of their cost base in China. The weaker currency will be a headwind for Australian commodity producers and those directly competing with the Chinese.
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