Weekly Reports | Sep 23 2016
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Unforgiving market continues; infrastructure sells off; flat outlook for construction; Canaccord Genuity covers receivables; Bell Potter initiates on TPI Enterprises.
-Stocks with valuation appeal and upgraded earnings likely to be the "new" defensive stocks: Macquarie
-Greatest downside risk to expectations in staples, A-REITs and industrials: Ord Minnett
-Infrastructure cash flow up but sector sells off on spectre of rising rates
-Banks can probably achieve strong CET1 ratios organically
By Eva Brocklehurst
Macquarie expects commodity, capital expenditure and consumer related stocks will be dominate themes through the next up-cycle but to achieve greater certainty on the trend requires more indication of where rates and the US dollar are going. Until more durable themes emerge, the broker expects the market to remain unforgiving, with much of the market upside in recent years driven by a bull market in defensive stocks.
Macquarie contends that disappointment over earnings is generally the death of high multiple growth stocks such as Aconex ((ACX)), CSL ((CSL)) and TPG Telecom ((TPM)) and bond yields are the death of high multiple dividend yield stocks such as Charter Hall Retail ((CQR)), GPT Group ((GPT)) and Scentre Group ((SCG)).
It will be stocks for which valuation appeal and/or earnings are being upgraded that will act defensively along with higher interest rates. Macquarie is looking for stocks where upgrades are accompanied by a low analyst forecast spread such as BHP Billiton ((BHP)), BlueScope ((BSL)), Downer EDI ((DOW)), Fortescue Metals ((FMG)), JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)).
In the current environment the broker believes a bigger discount is needed for long duration stocks such as Macquarie Atlas ((MQA)), Sydney Airport ((SYD)) and Transurban ((TCL)). Among stocks which have suffered downgrades but greater price declines the broker likes Commonwealth Bank ((CBA)) and Telstra ((TLS)).
Ord Minnett concludes from its analysis that downside risk to consensus earnings per share (EPS) forecasts has increased and capital management prospects are diminished. Market expectations have, nonetheless, picked up thus far in September and the broker notes the materials sector is supporting a large proportion of the upgrade. Staples, A-REITs and industrial sectors are the areas in which Ord Minnett envisages greatest downside risk to consensus expectations.
Following a protracted period of elevated capital management, the broker envisages a deceleration in activity, particularly for consumer discretionary, energy and health care sectors. Ord Minnett retains a positive view across the China/steel/iron ore complex but remains modestly concerned about earnings being flat in energy and the risks of increased supply from Nigeria and Libya.
Lower interest costs have boosted cash flow for infrastructure companies but Deutsche Bank observes the sector has now sold off amid expectations interest rates globally will start edging higher. The broker acknowledges the companies will argue that cash flows will not be affected by rising interest rates until a majority of debt is refinanced but believes some of the terms and conditions may change.
Deutsche Bank calculates that much of the current available cash flow would need to be re-directed to pay back outstanding debt and this ranges from 15-49% of the current cash flow currently going to shareholders. The broker is not yet convinced rates will rise but, once they do, there is likely to be more than one rise to normalise settings. Moreover, the broker is not convinced rising rates will accompany materially improved growth and believes this is a reason the sector has sold off so sharply on just the spectre of rising rates.
UBS expects FY16/17 will be the bottom for total construction and the outlook is near flat. While construction is unlikely to return to the pre-GFC boom years the environment is still considered to be better than witnessed in recent times. The broker expects mining construction will remain in a slump out to FY18/19 and the drag will diminish as the segment becomes smaller. Housing is expected to flatten and turn down sharply in FY18/19.
The gaps may be filled if UBS is underestimating the structural support in the economy from ultra-low rates and foreign demand. Moreover, public construction is expected to provide a solid, if only partial, offset. Hence, the necessary filler will be the long-awaited recovery in non-mining business investment, the broker expects.
Deutsche Bank estimates that the Basel IV reforms will entail a 50 basis points impact on major bank pro-forma CET1 (common equity tier one) ratios and this fits with the capital build-up required to push the majors further into the top quartile of global ratios. The broker expects the impact can be offset by organic capital generation rather than on-market capital raising. This would also address APRA's call for the majors to be unquestionably strong on capital.
Deutsche Bank believes 50 basis points increases from an average second half of FY16 pro-forma CET1 ratio of 9.3% could be achieved organically over FY17-19 with only National Australia Bank ((NAB)) having to rely on discounted dividend reinvestment programs. This would be consistent with forecasts for CET1 ratios of almost 10% by FY19. Such an outcome could lend share price support to the sector.
The broker's top picks remain Westpac ((WBC)) and National Australia Bank.
Wagering revenue growth slowed to 5.7% in the second half of FY16, partly related to luck, with turnover up 16.9%. UBS notes growth continues to be driven by new entrants in the market as well as elevated levels of promotional activity from corporate bookmakers. UBS observes the shift in consumer preferences continues to evolve with digital betting taking a higher market share.
While this is outside of the control of Tabcorp ((TAH)) and Tatts ((TTS)) the broker still expects Tabcorp can deliver 2-3% revenue growth while Tatts is affected by a significant migration of tote to fixed odds betting that is causing structural pressure in terms of yield, ie a company-specific issue. Wagering for Tatts is expected to endure declining EBIT (earnings before interest and tax) over the next two years.
Canaccord Genuity estimates the investable market for debt ledgers in Australia is around $440m and around 80% of this will originate with the four major banks, GE Money and Telstra. As a result, unsecured personal loan and credit card balances represent the overwhelming majority of debt purchased in Australia in FY17.
The broker notes Credit Corp ((CCP)) is the largest purchaser of debt ledgers and has been able to expand its annual purchases consistently while maintaining the quality of its balance sheet. A Buy rating and $19.42 target kicks of the coverage of the stock.
Collection House ((CLH)) is likely to be the third largest purchaser this year. The company downgraded in FY16 and a reduction in purchasing activity was noted for the second year running. Management changes provide the opportunity to re-position the business, Canaccord Genuity believes and may also mean some near-term write downs. The broker initiates with a Sell rating and $1.06 target.
Pioneer Credit ((PNC)) listed on ASX in 2014 and is in the early stages of growth with a significant increase in ledger investments, which the broker observes have only just begun to be outpaced by annual cash collections. Canaccord Genuity initiates with a Hold rating and $1.85 target.
TPI Enterprises ((TPE)) combines long-term growth outlook in healthcare with the volatility inherent in the agricultural sector and Bell Potter initiates coverage with a Speculative Hold rating and valuation of $3.17.
The exposure to agriculture relates to poppy growing in Australia, where local growers producer around 45% of the raw materials for narcotic production globally. Until recently this industry was confined to Tasmania. The company has now relocated to the mainland and the broker expects this move may increase the number of growers and result in a far more competitive environment, boding well for the TPI.
The Melbourne production facility is the first commercial scale, solvent free extraction plant in the world and, relative to other producers, its cost of production should be significantly cheaper at scale, Bell Potter contends, proving a sustainable cost advantage.
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