The Wrap: Amazon, Housing & Hospitals

This story features SUPER RETAIL GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: SUL

Amazon; housing construction; general insurance; hospitals; McPherson's; Apiam Animal Health; Beacon Lighting.

-Australian department stores seen most exposed to Amazon, not specialty retailers
-National housing market expected to be modestly oversupplied by late 2018
-Credit Suisse more positive on commercial insurance premium outlook
-Affordability and mix issues to dilute hospital revenue growth

By Eva Brocklehurst

Amazon

Morgan Stanley believes the market is mispricing the impact of Amazon and its entry to Australia. The broker believes, while Amazon is yet to release details of its range, pricing or its Prime offer, it should be comparable to other developed countries. Retail prices in Australia have reduced considerably in recent years and are now only at slight premiums to the US, so the broker does not envisage Amazon compressing Australian prices.

However, the broker believes Australian department stores, as well as eBay, will be more exposed to the Amazon onslaught than leading specialty retailers. Australia has overbuilt department stores compared with other developed markets and the long leases for those stores mean they cannot close as they become unprofitable. Moreover, online offers from department stores are weak and they generate a disproportionate percentage of sales from apparel, a category where Amazon is successful.

Morgan Stanley believes category killer retail formats such as Super Retail ((SUL)) and JB Hi-Fi ((JBH)) will be successful in countering Amazon, given the experience in the US. JB Hi-Fi operates with far higher sales density versus its peers and has a market leading position, while the category exposure of Super Retail in automotive positions it favourably as does its loyalty programs.

Morgan Stanley suspects Wesfarmers ((WES)) will be most vulnerable, particularly Kmart and Target. Bunnings is expected to be relatively insulated. The broker downgrades valuations for the three businesses and cuts its rating on Wesfarmers to Underweight.

With the spectre of Amazon looming, UBS takes a closer look at the age demographic most likely to have the highest uptake in online spending and how this affects Australian Real Estate Investment Trusts (A-REITs) and associated shopping centres. Around 52% of the sector is exposed to Australian retailer assets and, therefore, the broker believes it important to differentiate between portfolios in an evolving retail environment.

UBS maintains an underweight call on the retail A-REIT sector. The broker's analysis of UK evidence suggests that the 18-34 age group has the highest proportion of expenditure online and has the highest take up of Amazon Prime subscriptions. Mirvac Group ((MGR)) has the highest exposure to this age cohort in terms of the shops in its malls, which are considered most at risk for leakage to online retail.

At the other end of this scale, Charter Hall Retail ((CQR)) has the lowest proportion of malls exposed to this age cohort. While landlords are proactively increasing exposure to entertainment, food and retail services, historical data suggests to UBS the retail market will evolve faster than the malls can adapt.

Housing Construction

There are indications that the housing construction cycle may soon reach its peak and detract from economic growth as soon as 2018. National Australia Bank analysis suggests that new commencements could drop more than -13% this year and -7% in 2018.

Nevertheless, the analysts believe much of the commentary in the public domain is alarmist. Lower construction approvals, diminished spare capacity and tougher credit conditions are likely to slow the rate of completions, while the industry has previously shown the ability to self regulate supply.

Meanwhile, fundamentals for demand remain quite strong, supported by solid population growth, particularly in Victoria. There is also a high degree of pent-up demand in some markets, particularly Sydney, which should absorb new housing stock. Nevertheless, the analysts envisage the national housing market to become modestly oversupplied by late 2018.

General Insurance

Credit Suisse has taken a more positive outlook for local commercial insurance premiums and increases assumptions around the magnitude of increases in 2017. The broker now believes the local general insurer should be in a position to achieve 3-5% increases in premium rates this year.

The broker elevates Insurance Australia Group ((IAG)) to its top pick and an Outperform rating, as the stock offers the most upside risk for outer-year earnings. Conversely, with increased uncertainty around general insurance reinsurance and life insurance earnings, the broker downgrades Suncorp ((SUN)) to Neutral.

Nevertheless, Credit Suisse continues to prefer Suncorp ahead of the non-general insurance names such as AMP ((AMP)), Medibank Private ((MPL)) and QBE ((QBE)). The broker maintains Outperform ratings on Austbrokers ((AUB)) and Steadfast ((SDF)), envisaging upside risk to earnings and valuation.

Hospitals

Credit Suisse believes the current affordability issues for private health insurance, with cover being reduced and/or increases in excess, and a trend towards more day only admissions to hospitals will dilute hospital revenue growth.

The broker now assumes private hospital organic volume growth of 2-3% over the short to medium term. The broker has also delayed the ramp up in the utilisation of additional capacity in its estimates.

This is of most consequence for Healthscope ((HSO)) because of the relative increase in its capacity associated with several large projects that were recently completed. The broker downgrades Healthscope to Underperform from Neutral and Ramsay Health Care ((RHC)) to Neutral from Outperform.

McPherson's

Shaw and Partners initiates coverage on McPherson's ((MCP)) with a Buy rating and $1.85 target. The company has sold all its less profitable and non-complementary businesses as part of a makeover amid efforts to improve the balance sheet. The company now chiefly supplies health, wellness & beauty products and home appliances in Australasia, Europe and Asia.

The broker notes the outlook for revenue growth has been dampened by the loss of a key agency contract, as Coty's acquisition of P&G's specialty beauty business will mean the loss of the PM&G fragrances contract in April 2018, creating a $15-20m annual revenue hole for McPherson's.

Shaw and Partners expects this will be filled by domestic and offshore revenue growth in the core products and new agency arrangements. The broker believes a sale of home appliances would further reduce debt and help drive a re-rating of the stock towards other health and beauty peers.

Apiam Animal Health

Apiam Animal Health ((AHX)) has guided to FY17 operating earnings (EBITDA) of $7.2-8.5m. This disappointed Shaw and Partners and was a result of two factors, including implementation costs from IT initiatives and margin compression. The broker understands the company had a poor April when a combination of product mix and client ordering patterns resulted in reduced margins.

Shaw and Partners finds no issue with the performance of the business at the top line and FY18 should benefit from a full 12 months contribution from the Quirindi Veterinary group. The broker believes the low end of the company's earnings guidance reflects a worst-case scenario, in which the trading pattern witnessed in April may extend to the relatively important months of May and June.

Nevertheless, the stock regularly experiences swings on a monthly basis and board is suspected to have erred on the side of caution in providing the broad range of guidance. Shaw and Partners retains a Buy rating and $1.20 target.

While some of the seasonal factors in the March quarter should reverse in FY18 Bell Potter suspects the elevated cost structure is likely to persist. The broker remains favourably disposed to the stock and the company's exposure to a consolidating veterinary market but notes the earnings base is now 30-40% below pro forma FY16 levels.

There is a higher debt balance from recent acquisitions and, on downwardly revised forecasts, the stock is as compelling. Hence,  the broker downgrades to Hold from Buy. Target is reduced to $0.87 from $1.44.

Beacon Lighting

Wilsons initiates coverage of Beacon Lighting ((BLX)) with a Sell rating a $1.18 target. The broker is encouraged by management's experience and a dominant market share but remains concerned about the impact of softening renovations activity and a slowing in secondary housing markets, as well as online competition.

The stock is calculated to be trading at a premium of 19.8% in terms of the price/earnings ratio to its closest peer, Nick Scali ((NCK)) and at a premium of 53.4% to the specialty retail sector, which has similar average margins to Beacon.

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