The Wrap: Banks, Malls & Health Insurers

This story features LINK ADMINISTRATION HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: LNK

Weekly Broker Wrap: equity strategy; bank levy; mortgage brokers; diversified financials; shopping centres; private health insurers; GUD Holdings and NetComm Wireless.

-Material risk governments raid the bank levy and it continues to rise
-Sweeping changes recommended to mortgage broker remuneration
-Expense management to become the main driver for market operator earnings growth
-Quality in Scentre Group's portfolio of malls should stand it in good stead
-Credit Suisse believes private health insurer stocks not justified at current levels
 

By Eva Brocklehurst

Equity Strategy

Citi highlights an ongoing shift of capital to passive from active equity fund management. This is especially intense in the US, where around 40% of the US institutional and retail money sampled by Morningstar and EPFR is now passive. Citi believes this represents a major challenge for active fund managers, although 40% market share could create new opportunities for active managers as distortions are exploited.

Reality check: the broker points out that this does not mean that 40% of the US equity market is now owned by passive funds. Shareholder data for major listed companies suggest passive investors own just 22% of the US market free float and the rest of the world is assumed to be nearer 10%. Citi suspects this could be why there is little evidence of major market distortions created by the rise in passive investing.

The broker also asserts investors should not confuse the passive market share of asset management with passive ownership of the stock market. The former is more important in considering the profits of asset managers while the latter is more important in considering the behaviour of share prices.

Bank Levy

Major bank reactions to the introduction of a levy in the federal budget have been fairly predictable, UBS ascertains. With major political parties supporting the levy the broker's concern is that a Pandora's Box is now open, suspecting the levy may be raided by future governments and a material risk that it continues to rise, noting the UK bank levy was increased nine times.

The broker believes the best way to close the box is for the banks to push hard against it. The levy could be passed on in full to investment property borrowers and foreigners, the two groups regularly accused of causing the Australian housing bubble and affordability crisis. This could involve an increase of 40 basis points to investment property loans, which may be partly offset by offering a discount to first home buyers. The benefit is that it increases negative gearing tax deductions, with the cost to borrowers shared with the government.

On the negative side it could risk popping the housing bubble as well as increase the likelihood of a Royal Commission with unknown consequences. Alternatively the banks could share the pain and pass some of the costs onto staff, customers and shareholders. The third option is to comply with the government's wishes and accelerate longer-term cost reductions, but UBS contends, if the banks do not push back hard, future governments could consider them an easy target for budget repair.

Mortgage Brokers

Are mortgage brokers overpaid? This is the case UBS observes from regulatory reviews into mortgage broking, which have called for sweeping changes to the way the brokers are remunerated. Broker loans appear to be larger, have higher loan-to-valuation ratios and more likely to be interest-only. They are also paid off more slowly by borrowers than bank-originated mortgages. Despite perceptions brokers achieve the best rate for customers there was no evidence that this was the case. Broker originated mortgages therefore cost customers more over the life of the loan.

UBS believes the key recommendations of the reviews. to adopt approaches to remuneration that do not directly link payments to loan size. are appropriate. The broker believes the payments to brokers are an illustration of excesses built into the financial system following 26 years of economic boom. UBS expects the banks to negotiate materially lower fee-for-service mortgage commissions in coming months and, over time, the value add from mortgage brokers is likely to become marginalised. UBS also expects the benefits from this review of the industry should be passed on to customers, which could help offset the anticipated re-pricing for the bank levy.

Diversified Financials

Deutsche Bank observes market operators have tended to have significant leverage to rising markets over time although changing ownership structures and fee pressures will make expense management the main driver of earnings growth. The broker prefers Link Group ((LNK)) in the diversified financials segment, as it has a significant cost management program and a stable revenue outlook. The broker envisages nearly 40% upside to earnings from delivering on the targeted margin and rates the stock a Buy.

Computershare ((CPU)) and ASX ((ASX)) are rated Hold. While both have a solid growth prospects, Deutsche Bank believes the multiples reflect fair value at present. The broker likes the growth options in the new mortgage servicing business by Computershare and notes it also has significant leverage to rising interest rates but remains concerned about customer attrition in the core registry business. The ASX monopoly position and strong cash flow are supportive, but the broker believes structural changes to share ownership with the rise of passive funds are likely to act as a drag on turnover and liquidity in the medium term.

Shopping Centres

The retail asset segment will have to rapidly evolve to keep pace with slowing sales and the threat of e-commerce, UBS asserts. The broker believes assets with superior demographics will still grow sales of tenants, attract retailers and maintain pricing power. The broker analyses catchment population densities and purchasing power, which highlights the quality of Scentre Group ((SCG)) and suggests the mall portfolio of Mirvac Group ((MGR)) is better than anticipated. UBS retains a preference for Scentre Group. Stockland ((SGP)) was worse than anticipated across both regional and sub-regional malls.

The broker makes revisions to net operating income growth for the sector, expecting it to be around 1.5% for FY20-21. This reflects a lower sales growth environment as well as increased online sales penetration. Operating metrics are not expected to improve in 2017 and the broker believes it is too early to end the underweight outlook for the sector.

Private Health Insurers

APRA has released March quarter statistics on private health insurance, which indicate a 41 basis points decline in the industry's net margin on premium growth. This makes Credit Suisse sceptical about the shares of both nib Holdings ((NHF)) and Medibank Private ((MPL)), believing they are not justified at current levels. The broker downgrades to Underperform on both stocks.

Credit Suisse acknowledges quarterly data can show some volatility and this quarter was affected by Easter but the trends appear consistent with expectations that profit margins are unsustainable. The broker observes, as policy-holder growth slows, the insurers are spending more time attempting to win business from one another, partially absorbed by a period of inflated gross margins.

GUD Holdings

GUD Holdings ((GUD)) should go up a gear, Shaw and Partners believes. The investor briefing impressed the broker with the way the business is pursuing opportunities to build market share in the automotive spare parts market. This is predominantly served by smaller under-resourced entities that are finding it increasingly difficult to compete.

Out of a $3bn after-market industry, the company is the largest supplier and only generating around $250m in revenue per annum. The analysts believe this equates to an opportunity for a company willing to exercise a relatively large balance sheet and superior expertise.

Shaw and Partners cites the acquisition of Brown and Watson, which has provided back-to-back double-digit sales growth. B&W operates in segments of the automotive parts market with an estimated $500m but only has 20% market share. Shaw and Partners has a Buy rating on GUD Holdings and a $13 target.

NetComm Wireless

Canaccord Genuity observes several recent items of news that were positive for Netcom Wireless ((NTC)) have not benefited the share price. The broker believes the company should be an obvious beneficiary of the changes announced by the NBN, where the number of homes set to receive Fibre To The Distribution Point (FTTDP) are increased by 43%. These were previously expected to receive Fibre To The Node (FTTN), which forms the base of the current NBN roll-out.

The company holds a master purchase agreement for the supply of hardware to NBN and the increase in the scope of the FTTDP roll-out means the broker's forecasts for specific elements of equipment are increased. NBN has also announced it has achieved a 1GB speed on a test site in Ballarat, Victoria, for fixed wireless, which offers the prospect of future upgrades for this technology.

A 100Mbps product is expected to be launch in 2018, bringing fixed wireless into line with fibre-based executions. AT&T has begun marketing its fixed wireless product to rural customers in the US and the signal for Netcomm Wireless is that the offer has been positively received, as customers take up the opportunity to improve broadband services. Canaccord Genuity increases its valuation on the stock, raising the target to $2.10 and upgrading to Buy from Hold.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms