Weekly Reports | Oct 28 2016
This story features TELSTRA CORPORATION LIMITED, and other companies. For more info SHARE ANALYSIS: TLS
CPI outlook; Oz economy and coal prices; telcos under an NBN; Ardent Leisure; food inflation; big infrastructure projects.
-Perceptions the RBA's easing cycle is over are misplaced in Macquarie's, Morgan Stanley's view
-Coal price spike sets Australia up for possible trade surplus
-Trading multiples seen unwinding for telcos as the benefits of structural tailwinds dissipate
-Sugar price rises spearheading likely inflation in some packaged grocery
-Goldman Sachs considers Lend Lease well placed for new major infrastructure projects
By Eva Brocklehurst
Australia's headline consumer price index (CPI) in the September quarter was better than Macquarie expected and the outcome removes the trigger for a November cut to the Reserve Bank's cash rate. That said, perceptions that the potential inflection point evident in the headline CPI could mean the easing cycle is over are misplaced in the broker's view.
For its outlook on the cash rate to be derailed, Macquarie believes inflation prospects need to be boosted to the point where the central bank is concerned about containing a sharp break-out in inflation. Morgan Stanley also envisages little change in the low inflation trend.
Core measures of inflation edged down to 1.5% year on year, leaving room for further cuts to official rates in the broker's opinion, if the labour market weakens over 2017. Morgan Stanley expects the slowdown in the housing cycle will impact growth and the labour market over 2017 and into 2018, ultimately prompting the RBA to lower rates another 50 basis points to 1.00% in the second half.
The broker highlights the risk of a hard landing within apartment construction and argues that a broad downturn in housing would put up to 200,000 jobs at risk and mean unemployment would rise to 6.5%.
Oz Economy And Coal
Cuts to coal supply in China have meant coal prices have surged. Initial contracts for hard coking prices spiked by 116% in the June quarter to US$200 and spot prices rose another 20% to around US$240. Thermal spot and semi-soft contract prices also rebounded around 50%.
Together, coal prices, weighted by Australia's export share, have more than doubled and UBS observes this spike adds around $3bn per month to export values. The broker suspects the country's trade deficit will probably disappear in coming months, and may even turn to surplus.
If the price spike is sustained through the December quarter, total export prices are likely to rise around 5%, quarter on quarter. Assuming broadly flat import prices, it would also mean the terms of trade turn up 5%. Hence, even with some retracement of coal prices next year, nominal GDP appears set to grow 5% in 2017.
At face value, the spike in coal prices is a positive for government budgets but the broker's channel checks suggest the Commonwealth's MYEFO (mid year economic and fiscal outlook) will largely look through the price hike, given the May budget already projected nominal GDP of 4.25% in 2016/17 and 5% from 2017/18 onwards.
The easy money has been made in tier 2 telcos over the last ten years, Morgans asserts, as the sector has enjoyed structural tailwinds and the benefits of many acquisitions. More diverse companies, combined with low interest rates and strong earnings growth, have resulted in trading multiples virtually doubling from long-term averages of 6 to 12 times enterprise value/EBITDA (earnings before interest, tax, depreciation and amortisation).
This is now unwinding and the broker expects while Telstra ((TLS)) has never re-rated and it has most to lose under the National Broadband Network, it remains well hedged against this loss. The stock is considered relatively safe and holding up with respect to NBN market share.
Morgans expects TPG Telecom ((TPM)) could de-rate further, as unlike Telstra it is not compensated for NBN losses. The company needs to either double its consumer customer numbers, grow corporate share or reduce costs from iiNet.
Vocus Communications ((VOC)) has de-rated and now looks interesting to the broker. There is little risk to NBN earnings as the company already pays the higher access prices. Still, Morgans suspects investors will want to witness the integration of recent acquisitions and the cash flowing before revisiting the stock.
All the above three carry Hold ratings from the broker. Morgans prefers global satellite re-seller Speedcast International ((SDA)) in the sector, rating it Add, as it has a much larger addressable market and therefore a substantially longer pathway for growth.
The Dreamworld fun park has been closed until further notice after four fatalities at the site. Theme parks previously represented 33% of Ardent Leisure's ((AAD)) FY16 group EBITDA excluding health clubs, Citi observes.
The broker invokes lessons from the UK where Merlin had an accident in its Alton Towers park in June 2015 at the start of its peak trading season. There were two serious injuries but no fatalities. The principal cost to the group was a fine of GBP5 million. Citi calculates that attendance fell 20-30% at the park following the incident and the share price has now recovered to levels at which it was trading prior to the incident.
Based on the Merlin experience, Dreamworld attendance is expected to be adversely impacted over the upcoming peak Christmas period. Revised forecasts assume Dreamworld continues to trade but at lower attendances over FY17, and maintenance capex increases over the short term.
FY17 and FY18 EBIT (earnings before interest and tax) forecasts fall by 27% and 18%, respectively. The broker requires more clarity surrounding the cause of the incident and the duration of the park closure before returning to a Buy recommendation, and downgrades to Neutral.
The Australian supermarket sector has languished with industry growth of 3.2% over the past year but Citi believes low inflation will not last forever and fresh produce inflation is likely to rise. In 2017, some packaged grocery categories could also experience higher inflation.
Using wholesale data, banana prices were up 25% on the east coast and potatoes, tomatoes and lettuce have seen inflation of 18-52%. Fresh produce is about 10% of supermarket sales and recent inflation could add 1.0-1.5% to industry sales growth in the September quarter.
While there is clearly more supermarket competition with Aldi's growth and profile, Citi assesses most of the low inflation is a reflection of lower raw material prices. Many packaged groceries have experienced deflation such as in beverages, bakery and cereals, pet food and toiletries. However, the basket of soft commodities in these products is starting to rise, the broker observes, particularly for sugar. Sugar prices are up 85% for September 2016.
Goldman Sachs updates its infrastructure construction tracker to reflect the latest high priority projects and also for the recent awards of rail rolling stock contracts. The broker now estimates a pipeline of over $38bn in major infrastructure projects. From a top down perspective, a 3.4% compound growth rate in infrastructure construction investment is estimated over 2016-19.
Four mega projects underpin the pipeline, these being the Sydney metro rail city & south west phase, the Melbourne metro rail tunnel, the WestConnex (Sydney) and Western Distributor (Melbourne) road projects. These four represent 90% of the project pipeline and are due to be awarded in late 2017.
The broker notes Lend Lease ((LLC)) and Cimic ((CIM)) have the capability to participate as equity investors in public-private partnerships, which have been increasingly deployed in Australian infrastructure projects. Lend Lease has won 40% of the $5bn of projects awarded since the start of 2016, compared to its 12% market share in 2015.
This compares favourably to Cimic, where market share declined to 30% in 2016 from 73% in 2015. Goldman Sachs expects the recent momentum in market share will underpin growth in Lend Lease's Australian construction business.
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