The Wrap: Builders, Financials & Child Care

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Weekly Broker Wrap: Health insurers; salmon; building materials; diversified financials; office rents; child care; LiveTiles; and consumer sentiment.

-Morgan Stanley finds health insurance sector stretched and participation still challenged
-International prices having limited effect on domestic wholesale salmon market
-Macquarie prefers exposure to US building materials market
-Buoyant investment markets hiding headwinds for Australian wealth managers
-Strengthening demand expected to support growth in office rents
-Occupancy in child care to remain challenging until funding increases in July

By Eva Brocklehurst

Health Insurers

Morgan Stanley is cautious on the health insurance sector, reflecting stretched valuations and peak margins as well as challenges to participation. The broker believes the near-term benefits from subdued claims inflation is priced in.

Margins expanded in the September quarter, benefiting from modest growth in the average cost per treatment. Feedback suggests utilisation has been normalising recently.

The latest perception studies also show for the first time that consumers believe public hospital care is better than private. The broker suggests a growing perception that public hospitals provide adequate catastrophe cover risks is driving further downgrades to policies by healthier cohorts.

Morgan Stanley considers the nib Holdings' ((NHF)) brand is stalling while retention is poor. The broker has an Underweight rating. However, due to distribution via companies such as Qantas ((QAN)) and Suncorp ((SUN)) the business could sustain volume growth for now.

Morgan Stanley believes Medibank Private ((MPL)) is priced for success and retains an Underweight rating. The market appears to be backing Medibank to maintain its 8% margins and stem the downgrading.

The broker suggests attrition of the core brand is likely to continue and notes a lack of aggregator presence and shrinking pool of new-to-market customers.

Salmon

Ord Minnett observes international prices are having a limited effect on domestics wholesale salmon markets. Barriers include distance from other growing regions as well as import restrictions.

Wholesale salmon prices remain around $13.50-14.50/kg and the broker assumes wholesale prices of $14.60/kg for Tassal Group ((TGR)) and $14.25/kg for Huon Aquaculture ((HUO)) in FY18, although this includes varying proportions of smoked product which sells at a higher price.

The broker's checks suggests growing conditions are not being affected by warmer waters and there is nothing particular abnormal about temperatures at the moment. The broker maintains a Buy rating for Huon Aquaculture and a Lighten rating for Tassal.

Building Materials

Macquarie believes most of the factors supporting the performance of the building materials sector remain in place. The broker prefers exposure to the US market, and housing in particular, and notes rising property prices and the spectre of gradually rising interest rates are the main factors to watch for a change to this view.

Australian infrastructure exposures are also expected to feature in 2018. The broker prefers James Hardie ((JHX)) as the strong brand is expected to win back lost market share.

Reliance Worldwide ((RWC)) is expected to consolidate its position and a foray into Europe is also considered possible in 2018. Meanwhile, any upgrades to synergy targets are considered a de-risking event for Boral ((BLD)), supporting a re-rating.

Diversified Financials

UBS suggests buoyant investment markets over the last five years have hidden the multiple headwinds that are emerging for the revenue of incumbent Australian wealth managers. This comes as market share shifts away from market players and despite the supports from mandatory superannuation.

Weak wages growth is compressing gross flows as a percentage of assets under management, while an ageing population is supporting outflows and this is expected to limit future super flow prospects to just 0.5% of assets under management.

In comparison, net flows into investment products have been robust, assisted by an ongoing shift of direct assets to platforms. Fee pressure is expected to continue as legacy products assets churn to lower cost contemporary offers. UBS considers the current value discounts for AMP ((AMP)) and IOOF ((IFL)) warranted and retains a Neutral rating on both.

Meanwhile, platforms like Netwealth ((NWL)) are considered ideally positioned for growth, although flow and margin expectations implied by its PE of 41x appear unsustainable.

Elsewhere, UBS envisages credit spreads driving margin compression and eroding Challenger Group's ((CGF)) leverage while Perpetual ((PPT)) is still facing negative net flows. The broker retains a preference for global asset managers such as Janus Henderson ((JHG)) and Magellan Financial ((MFG)).

Australian Property

While many in the market believe the office rental growth cycle is finished, Citi believes strengthening demand will continue to support growth in rents, and forecasts supply to remain below the long-term average of 2% of stock. Market forecasts for city office rents are potentially starting to reflect this view, the broker suggests.

December quarter data indicates rents continued to grow at a rapid pace and Sydney's prime net effective rents were up 26% year-on-year and Melbourne up 13%. Citi suggests there is potentially more upside in Melbourne, as incentives remain higher versus historical levels.

Child Care

In the December quarter 72 new long day care centres were opened, taking the number of new centres opened in 2017 to 318. Canaccord Genuity notes the increase has been in excess of demand growth, particularly in certain areas of NSW, ACT and, more recently, Victoria.

From an occupancy perspective, the broker believes conditions will remain challenging until the government funding increases in July. Victoria continues to represent a large proportion of the new supply, as under-development combined with population growth has meant developers turned their attention to that state in the past couple of years.

Canaccord Genuity remains of the view that the level of new supply is greater than the increase in demand, currently, and this will cause problems in some areas in terms of improving occupancy.

Of the 72 centres opened, 18 a located within 2km of a G8 Education ((GEM)) centre while three are located within 2 km of a Think Childcare ((TNK)) centre. Canaccord Genuity retains a Buy rating on both.

LiveTiles

Subscription revenue at LiveTiles ((LVT)) was up 245% in December. Wilsons observes the product range is clearly resonating well. The stock has appreciated 117% since the broker initiated in October.

While remaining attracted to the multi-year growth opportunity around the company's Microsoft SharePoint overlay, the broker suspects a lot is priced in now and downgrades to Hold. Target is 66c.

EverBlu Capital takes up coverage with a Buy rating and 73c target, not expecting a significant profit until 2023 because the company is investing for growth. EverBlu proposes that LiveTiles should trade at a 10% premium to the market multiple in FY24.

Consumer Sentiment

The Westpac/Melbourne Institute Consumer Sentiment Index rose 1.8% in January to be up over 10% from its August low. Westpac observes this makes the most positive start to a calendar year since 2010, with the main positives being more confidence in the economy and jobs. Still, consumer assessments of their own finances are below long-run averages.

Risk aversion remains elevated. The modified indicator the analysts favour as a guide to actual expenditure rebounded 3.4% to be 5.7% above the average in the third quarter 2017. Despite the rise, Westpac suggests spending over the first half of 2018 is weak and consumer views on major purchases remain downbeat.

Despite a gain in the “time to buy a dwelling” index this is also at levels well below the long-term average. The Westpac/Melbourne Institute Consumer House Price Expectations Index fell a further 8.2% over the quarter to January and is in line with the long-run average.

The Westpac/Melbourne Institute Unemployment Expectations Index fell a further 5% in the quarter and, while it looks to be sustaining a break into positive territory, the analysts note the views are still not particularly optimistic.

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