Weekly Reports | Dec 23 2016
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Weekly Broker Wrap: Sugar tax; Linius Technologies; top IPOs in 2016; NAB economists' 2017 outlook; alternative 2017 outlook; and banks.
-Diversion in US/Aust monetary policy paths expected in 2017
-What are the wild cards for global markets in 2017?
-Support for sugar taxes grows, seen affecting Amcor volumes
-Linius Technologies opens up potential in transcoding
-IT sector accounts for majority of top 10 listings on ASX in 2016
-Ord Minnett retains positive outlook for banks in 2017
By Eva Brocklehurst
During 2017, National Australia Bank economists expect two factors affecting 2016 to partially unwind. Higher commodity prices will lift advanced countries' inflation rates and, with that, some of the prices/wages that are linked to the CPI. Economic slack is expected to reduce in most advanced countries, although notably not in Australia.
The economists expect the Reserve Bank of Australia to reduce the cash rate during 2017, as the US Federal Reserve continues to hike its rates. The diversion in these policy paths is common, with the economists noting this is the fifth such period over the past two decades. What is more unusual is that the RBA's cash rate will be below the US Fed funds rate, although not unprecedented as this was the state of affairs for much of the period from mid-1997 to late 2000.
Yet this is challenging for a current account deficit in a country like Australia that needs to attract substantial amounts of foreign capital each year. If the interest-rate gap is no longer supportive, Australian assets may need to cheapen to attract foreign capital, either via a lower Australian dollar or a wider bond spread to the US.
The economists expect the RBA's cash rate will be cut twice in 2017 to prevent unemployment rising in 2018 as housing construction slows. They note the housing cycle downturn that underpins their forecasts is quite moderate. A risk factor is failures in apartment settlements, which could accelerate or deepen the downturn. Brisbane and Melbourne are the areas most exposed.
The economists also note the non-mining economy has lost momentum in recent months, even as prospects for the end of the mining downturn have strengthened because of sharply higher commodity prices. The latter are not expected to be sustained.
The economists suspect the recent slowing in a number of sectors, including retail and in the non-mining states, probably reflects a combination of political/geopolitical uncertainties and the lagged effects of lower commodity prices, slower US growth in late 2015 and tighter credit conditions imposed on real estate investors and property developers.
While the case for the US dollar moving higher in 2017 is compelling, the NAB economists do not expect double-digit gains. Yield spreads should attract more capital but the US dollar fully reflects the shift in US yields and yield spreads since Donald Trump's victory. The economists do not expect US 10-year yields to make a sustained move above 2.75% in 2017. This is more consistent with a 3-5% rise in the US dollar rather than around 10%.
Alternative Market Outlook for 2017
City Index highlights 2016 as the year when events went against market expectations. What are the wild cards in 2017? In 2017 the analysts expect the US dollar to be the best performer. EUR/USD parity is on the cards as well as a move back to Y120 for the USD/JPY.
The drivers of such a move would include continued rises in US rates, a banking crisis in Europe and rising political risk. Rising US bond yields could lead to a very uncomfortable year for some emerging markets, including Turkey, which has an unsustainable US dollar debt position the analysts note.
Another potential in 2017 is that Iran and Saudi Arabia both renege on their plans to cut oil production, which in turn would lead to the breakdown of OPEC (Organisation of Petroleum Exporting Countries).
US financial stocks appear to be the best performers for the first half of 2017, as they continue to retrace their financial crisis losses on the back of the "Trump effect". At some stage in the first half the analysts expect the Dow Jones banking sector to return to its 2014 highs but the second half may be trickier, as markets question whether Donald Trump's policies can deliver the long-run growth that is promised.
The US dollar is expected to continue surging until Donald Trump gets in the way. The US trade deficit has exploded at the same time as fiscal largesse is putting up US government borrowing to unsustainable levels. This is leading, the analysts observe, to a questioning of the benefit of buying US Treasuries.
Another shot from left field the analysts would not rule out is that Donald Trump goes too far in terms of controversy and this leads to impeachment at the end of 2017. Fiscal largesse would take a back seat and lead to reduced expectations for US growth in 2018 and 2019, and the end of the global rally in equities.
US sugar taxes commenced with the city of Berkeley in 2015 and have been observed to be successful in reducing consumption of carbonated soft drinks (CSD). Recently, five more cities have passed legislation for a sugar tax, with the evidence suggesting to Morgan Stanley there is not just government pressure but also consumer support for the taxes.
The broker notes the structure of the taxes is evolving, with the latest introduction in California being channelled to health education. For Australian packager Amcor ((AMC)) it affects the company's rigid plastics revenue, and the broker suspects around 10% of revenues is related to packaging for CSDs.
Smaller packaging sizes are expected to be the initial result and, in time, some downturn may be expected in volumes. Not only are regular CSDs being affected but consumer awareness is also resulting in a drop in consumption of sweetened beverages such as juices.
Sugary beverages are estimated to affect 15-20% of the company's portfolio. The broker believes the trend should remain a watching brief and there may be a period of time before it shows up in Amcor's numbers, but it remains a risk.
Linius Technologies ((LNU)) and Village Roadshow ((VRL)) have demonstrated the technical feasibility of the Linius transcoding technology. The technology enables video files to be played out in a range of formats which may be different from the original. This can be done without the need for the original file to be translated first.
TMT Analytics believes, while the local transcoding market is only US$1.5bn in size, it illustrates the potential for the technology. The personalised advertising market, in particular, provides a very substantial addressable market. More than 40% of the global TV advertising value can potentially be delivered to consumers through channels that can currently already facilitate personalised advertising.
TMT Analytics estimates the current addressable market amounts at around US$79bn and is growing at the rate of double digits in the next several years. Linius Technologies is looking to sign up re-seller partners for its solution and commercial roll-out is slated for the next three months. TMT Analytics reiterates a Buy recommendation on the stock and observes fair value per share is $0.28.
Top 10 IPOs on ASX in 2016
OnMarket BookBuilds notes the technology and health care sectors accounted for six of the top 10 IPOs (initial public offering) in 2016, with the IT sector taking over from resources as the most active capital-raising sector on the Australian Securities Exchange. Analysts note the top performing IPO by a large margin was IT company Aurora Labs ((A3D)), with a 1540% gain.
AfterPay ((AFY)) also features on the list with a 178% rise. The biggest IT float of the year was software producer WiseTech Global ((WTC)), which enjoyed a 72.5% gain. Health care stocks Noxopharm ((NOX)) and Neurotech ((NTI)) made returns of 167.5% and 132.5% respectively.
CFOAM ((CFO)) and Ireland-based Kyckr ((KYK)) are in the top 10 as well. The analysts expect a similarly diverse list in 2017 as companies of various types come to Australia to access capital markets and a ready pool of investors.
Australian banking shares are now trading at around a 5% premium to Ord Minnett's fair-value framework, as a market-relative price/earnings ratio is restored to long-run averages. The broker suspects it may be time for the sector to consolidate recent gains.
Fundamentally, the broker retains a positive outlook for 2017, in terms of operational performance, via better margin and cost outlook, and investor positioning, as many domestic investors are still underweight the sector. The analysts note, starting the year with around a 15% sell-off in global financials, the bank sector's share price performance has struggled in the face of negative revisions to earnings per share through most of 2016.
Ord Minnett observes US banks have re-rated on higher bond yields and potentially lower US corporate tax rates, but Australian banks do not benefit from these themes and a first glance suggests that the recent rally can be ascribed to a free ride in the wake of the US presidential election.
Yet, the broker believes local bank shares are being driven by a more benign outlook for regulatory capital, which brings more certainty to dividends, an improved operational outlook and increased uncertainty outside of the banking sector. While bank shares may need a short period of consolidation, the broker continues to envisage upside in 2017.
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