The Wrap: Online Retail, Insurance & Property

This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW

Weekly Broker Wrap: online retail; general insurance; banks; property; Starpharma; UltraCharge; and Macquarie Telecom.

-Overly pessimistic outlook on online retail could present opportunity in the medium term
-Insurance Australia Group outperforms in general insurance survey
-Borrowers on interest-only mortgages more likely to use credit cards, consumer finance to manage higher costs
-Case for asset upside among office-exposed stocks
 

By Eva Brocklehurst

Online Retail

Analysis from UBS indicates online retail sales in Australia have grown around 14%, compound, over the past five years and 13% in the past year. This compares with total retail sales growth of 3.8% and 2.9% respectively. UBS concludes that penetration of online in Australia will accelerate. Local retailers are well placed to capture share although this will put pressure on margins, with Amazon being the main driver of this pressure.

The broker continues to believe that an overly pessimistic outlook regarding the impact of online retailing and Amazon is being priced into the Australian retailer sector, and this presents an opportunity in the medium term. The broker expects retailers with an attractive valuation and differentiated offering will be best placed to limit the impact of the shift to online.

In the ASX100 UBS prefers Woolworths ((WOW)) and Harvey Norman ((HVN)). In the ex-100 sector the broker likes Bapcor ((BAP)), Premier Investments ((PMV)) and Super Retail ((SUL)). Conversely, those retailers most at risk and least preferred are in high-margin generic categories, such as Myer ((MYR)) and The Reject Shop ((TRS)).

Coinciding with this, online penetration landlords will need to adapt to changing consumer preferences. Australian consumers frequent shopping centres more often than consumers in other countries yet visits are declining, as online sales increase, although the high street retailer is affected the most.

Important draw cards, from the UBS evidence, are diversity in shops, dining, services and unique offerings and international brands. Click & Collect is considered an opportunity, as around two thirds of consumers have indicated they spend more when they elect Click & Collect.

Shopping malls are expected to become lower growth and more management intensive. The broker prefers Scentre Group ((SCG)) to Vicinity Centres ((VCX)) although both are Buy rated.

General Insurance

Deteriorating performance metrics support an underweight stance on the general insurance sector, Macquarie believes. The broker uses proprietary survey data to analyse broker satisfaction with the offerings of the top five insurers and notes this measure has deteriorated to the lowest point in five years. Within this measure, Insurance Australia Group ((IAG)) has outperformed the average and widened its lead.

Macquarie expects competition among insurers will remain high in the broker channel and put pressure on incumbents, resulting in a loss of market share to the likes of Chubb, AIG and Hollard, that have it all expanded risk appetite in the last year.

Survey feedback consistently indicates that while IAG's performance is strong versus its major peers it is on a declining trend versus its own performance year-on-year. Perceptions of QBE Insurance ((QBE)) continue to decline, with its personal and motor & home offerings ranked the lowest across almost every measure.

Banks

Morgan Stanley's survey of mortgage customers indicates that those borrowers with interest-only mortgages are higher risk. They are more likely to use credit cards and consumer finance to manage their higher costs, despite making lower payments than those on principal & interest loans. They are also more likely to sell the property if interest rates increase.

This is consistent with the broker's findings that interest-only mortgage holders are saving less. The gap is most pronounced for owner occupiers. The broker considers it likely that APRA's new capital framework will introduce greater risk weightings for higher risk mortgages.

Morgan Stanley has a negative stance on banks given the challenging outlook for 2018-19, as a weaker domestic economic cycle continues along with re-emerging headwinds to margins. Increased political and regulatory scrutiny and an increase in non-housing loss rates are also factored in to the soft outlook.

Property

A report from Savills supports the case for asset upside in office-exposed stocks, Morgan Stanley suggests. Compared with the other ten world cities included in the report, Sydney's A-grade property capitalisation rate of 5.32% is ranked the highest and its effective capitalisation rate of 4.14% is ranked the third highest.

A property risk premium of 174 basis points remains broadly in line with the levels of London and New York, despite a more attractive supply/vacancy outlook over the next three years.

Morgan Stanley believes the next source of upside is reducing the downtime and increasing retention in office rental assumptions. The tight market conditions in Sydney and Melbourne CBD markets could mean further reduction in downtime assumptions for limited capital expenditure.

This is in line with Investa Office's ((IOF)) announcement that ANZ Bank ((ANZ)) will re-commit to 63% of the existing space occupied at 347 Kent Street, Sydney, on an as-is basis, with the option to take up a further 15% of the building by May 2018. Morgan Stanley calculates this transaction reduces rent at risk in FY19 by -6% and de-risking is likely to result in further upside to book values.

Starpharma

Starpharma ((SPL)) has submitted its application to the US FDA for VivaGel in Bacterial Vaginosis indications. The company has both FastTrack and qualified infectious disease product designation, which makes it eligible for priority review. Bell Potter expects a six-month review time with a launch in FY19.

The achievement of the filing milestone should assist the company in its partnering negotiations for VivaGel. A licensing deal is expected for BV in the near term and this should lead to a further cash injection. Revisions to the model have resulted in Bell Potter increasing net profit forecasts for FY18-20 because of the increased probability of success. This lifts valuation to $1.78. The broker maintains a Buy rating.

UltraCharge

UltraCharge ((UTR)) is building an intellectual property portfolio around rechargeable battery technology. The company is working with US-based chemical company, Chemours, for further development and production of anode material to be used in lithium ion batteries. Chemours specialises in performance chemicals, including titanium oxide, currently used as anode material.

The JV will scale up production of sample material to be used by prospective customers to test UltraCharge's nanotubes technology. TMT Analytics believes this JV will enable the company to substantially expedite developing, manufacturing and commercialisation, anticipating the company can derive future licence fees and royalty payments as well as a revenue share from potential joint manufacturing. TMT Analytics has a Buy rating and 8c target.

Macquarie Telecom

Macquarie Telecom ((MAQ)) has launched an off market offer to acquire Bulletproof ((BPF)) at 11c per share. Macquarie Telecom has entered a call option agreement to acquire the CEO's 16.1% holding. A 90% acceptance condition and no material adverse change are conditions to the offer.

Canaccord Genuity believes the acquisition will fill a gap in the company's cloud offering with exposure to public cloud service providers, such as Amazon Web Services and Microsoft Azure. Recurring revenue stood at $40m in FY17 representing growth of 6.5% although Bulletproof was negatively affected by a number of factors during that year, including changes in customer procurement behaviour, which increased churn.

Churn is expected to have peaked towards the end of the first half of the year. Canaccord Genuity believes the logic in the transaction is sound and it is now a question of stabilising and improving the Bulletproof earnings profile.

Note from the Editor: in a left field twist to the Macquarie Telecom & Bulletproof story, Microequities Asset Management, major shareholder in the latter, has increased its stake to 6.50% while declaring it intends to reject the take-over proposition as it is considered undervaluing the recovery that is seemingly taking place at Bulletproof. This story is to be continued, no doubt.

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