Weekly Reports | Sep 02 2016
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Earnings season wrap up; apartment approvals spike; consumer spending growth; harsh outlook for Wellard; Telstra's dividend dilemma.
-Ord Minnett scales back financials and health care, increasingly favours metals & mining
-UBS suspects market vulnerable to a set back but any correction likely to be shallow
-Developing oversupply of apartments to gain momentum in 2017 and 2018
-Weaker wealth trend seen reducing spending growth in 2017
-Wellard in breach of facilities and may be forced to sell assets
-Does Telstra need to change its dividend policy?
By Eva Brocklehurst
Reporting Season Wrap
Ord Minnett is disappointed with reporting season. FY17 earnings projections have slipped by 1.3%, and only 24% of the S&P/ASX 200 index beat expectations for FY16. The broker has scaled back its position in financials and health care, after the two sectors fell 2.5% and 3.7% respectively in the month.
In contrast, Ord Minnett observes the metals & mining sector is increasingly favourable and moves its weighting to Neutral. The broker is also encouraged by the positive aspects of the consumer discretionary sector and reinstates it to Overweight.
The broker contends that two stalwarts of the yield play have languished, with telecommunications edging out insurance to claim the wooden spoon. Ord Minnett observes the slide in utilities in the month also looks to be underpinned by fundamentals with AGL Energy ((AGL)) exerting the most drag, and its FY17 earnings estimates scaled back 3.5%.
Meanwhile, energy was resilient, up 2.8%, and materials and staples were up 1.9% and 2.6% respectively in the month. The broker shifts its materials weighting to Neutral and remains Underweight on staples.
UBS suspects a degree of complacency has crept back into the investment landscape and the market could be vulnerable to a setback. Nevertheless, recession risks for the US and Australia are low, in the broker's opinion. Hence any correction may again be shallow and present a buying opportunity.
The broker remains cautious, but not outright bearish, about the market and continues to believe stocks offer better prospects than bonds and cash on a 6-12 month view. UBS is, on balance, underweight on the defensive yield trade, envisaging it is overvalued versus other parts of the equity market.
The broker considers the market is likely under-pricing a tightening from the US Federal Reserve. Still, the Fed remains constrained by a lacklustre global economy and any bond yield back up is expected to be moderate.
Building approvals sustained the largest monthly rise in 2.5 years in July, Citi notes, and the gain was led by NSW, followed by Western Australian and then Queensland. The broker also observes the rise was completely driven by a large spike in apartments, extending the trend in the medium and high density segment of the market. It also underlines the emerging trend of softly falling owner-occupier approvals on the headline result.
Citi suspects the risk that a number of approvals do not turn into dwelling starts is growing. Apartment completions lag starts by 1-2 years so the developing oversupply should continue to build in 2017 and 2018, with the broker estimating completions will probably double across the eastern states.
Relative to underlying demand, Brisbane is considered oversupplied as is inner Melbourne. Sydney is still catching up and the broker can only suspect that the underlying demand in Sydney is able to absorb such a large impact from building approvals in the supply chain.
Citi does not envisage conditions are sufficient for contagion from projected apartment price declines in some areas to spill into broader house price declines.
Wealth And Consumer Spending
UBS argues that the pick-up in consumer spending since 2013 is sustainable and, so far, solid jobs growth and better consumer cash flow from low inflation have driven stronger real spending, despite low wages growth.
UBS updates its model to calculate how a flatter outlook for housing & equity prices, and record low wages growth, weighs on the consumer, despite recent reductions to interest rates. The lagged impacts of this weaker wealth trend is conspiring to drag spending growth lower in 2017, in the broker's opinion.
Hence, UBS trims consumer growth forecasts to 2.5% from 2.8% for 2017, with 2016 little changed at 2.9% from 3.0%. For retail sales, a near-term boost to household cash flow from lower petrol prices, tax and rate cuts should mean a return to the growth range of 4-5% from the current level under 3%.
Deutsche Bank downgrades Wellard ((WLD)) to Hold from Buy in the wake of the FY16 results, which signalled the company is in breach of its working capital facility and may be in breach of certain financial covenants. The broker reduces the target to 30c from 75c. Deutsche Bank observes that earnings have been affected by the inability to pass through the historically high cattle prices to traditional customers in Indonesia and Vietnam.
Morgans observes, should Wellard be unable to renegotiate its loan facilities, the business will not continue as a going concern and it may be forced to sell assets. Given conditions have deteriorated further in FY17, the broker has little confidence in forecasts. Morgans maintains a Reduce rating and considers the stock a high-risk investment. Target is 25c.
Credit Suisse believes Telstra ((TLS)) has an emerging dilemma over its dividend. The earnings gap as NBN payments roll off is rapidly approaching and will result in core recurring earnings per share (EPS) falling significantly over the next 2-3 years. This core EPS is forecast to fall as low as 23.2c per share in FY19.
Credit Suisse maintains that if Telstra sticks with its current dividend policy, the dividend would likely need to be cut in the outer years. If Telstra changes its policy and pays a dividend above EPS for a period, earnings from areas such as mobile and network access could have time to catch up with the pay-out, the broker contends.
There is no near-term dividend risk, as NBN payments should support cash flow and reported earnings, but Credit Suisse envisages dividend sustainability will start to worry investors in the medium term. Moreover, history shows that Telstra's yield tends to rise, ie the share price declines, when there is concern about the long-term sustainability of its dividend.
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