Weekly Reports | Feb 09 2018
Weekly Broker Wrap: consumer stocks; automotive retailers; energy; health insurers; and lithium stocks.
-UBS favours retailers with drivers outside of the domestic macro environment
-Beneficial trends for automotive retailers
-Citi envisages gas pricing will ultimately soften in the second quarter of 2018
-Credit Suisse argues profit levels in health insurers, to which downside risk is applied, could be higher
-Lithium producers to remain in focus as electric vehicle market develops
By Eva Brocklehurst
During December, supermarkets sales growth was again below trend, up 2.4%. Household goods results were mixed with a strong month for electrical and hardware and a soft outcome for furniture. The retail sales data from the ABS shows growth of 2.5% in retail sales overall, slowing from November's 2.9% and below the 12-month run-rate.
Early feedback on January numbers suggests to UBS that growth has moderated. The broker continues to favour companies with drivers that are outside of the domestic macro environment, namely Harvey Norman ((HVN)) which is benefiting from efficiency programs and diversification of earnings.
Woolworths ((WOW)) is also preferred, given its improved execution. UBS remains negative about department stores, given too much space and the risk from Amazon.
Supermarket growth continues to track below expectations and, while expecting growth to lift in the second half, UBS acknowledges the forecast appears optimistic. Nevertheless, the larger chains continue to outperform the independents and this provides comfort in the broker's forecasts for both Coles ((WES)) and Woolworths.
UBS believes the market remains competitive but not irrational. The broker's proprietary study shows Woolworths lowered food prices at a faster rate than Coles over the December quarter. Still, margins are not seen at risk. The high rates of investment are attributed to benefits from cost reductions, operating leverage and terms.
The broker envisages risks to consensus estimates for Coles, as supplier feedback signals trends have deteriorated and the supermarkets are unlikely to meet management expectations for a recovery in the second half.
Total volumes of Australian car sales rose 4.3% in January. All states grew, except NSW. Western Australian growth was driven by business sales. When adjusting sales by dealerships in operation the 12 months in each state for Autosports ((ASG)), UBS estimates new car volumes turned positive after a year of declines.
The broker believes the company will benefit from a long-term trend towards luxury.prestige cars amid the maturing profile of its greenfield sites and increased number of service bays. There is also ongoing consolidation opportunities. UBS retains a Buy rating and $2.70 target.
For Automotive Holdings ((AHG)) overall car sales have been positive in Western Australia for four out of the last six months. Conditions remain choppy but the broker observes a more certain earnings profile for the company, assuming the successful divestments of the refrigerated logistics division.
While stock is trading on a relatively undemanding multiple, UBS would like to witness underlying growth in the business before taking a more positive view and maintains a Neutral rating and $3.70 target.
Citi observes retail fuel margins have held up as the discounting cycle is delayed. The second half profit guidance for Caltex ((CTX)) signalled softer retailer margins, which the broker suspects was because of a key discounter returning to competition in October. However, the data shows peak margins have remained for longer than normal.
Meanwhile, domestic gas prices continue to rise because of heatwaves in the middle of the month of January. Pipeline data suggests to the broker that production was curtailed amid growing gas supply from storage and domestic gas supply from LNG projects that are disconnected from pricing.
Citi estimates over 400TJ/d of spare production capacity exists in both the WA and eastern markets at present.
GLNG average production was down -18% in January month on month and well below the near-term guidance run rate. With upstream field production data flat, Citi suspects this can be attributed to the cessation of some short-term third-party supply contracts and GLNG physically diverting gas to the domestic market.
Citi continues to believe that as Chinese demand seems to be softening, gas pricing, while remaining constructive, will ultimately soften through the second quarter of 2018, amid reduced demand and the start up of new projects.
The broker considers the energy sector expensive and oil prices the main risk. Beach Energy ((BPT)) has now replaced Woodside ((WPL)) as the most expensive name, with the current share price inferring a long-term oil price of US$79/bbl.
The broker considers there is limited value in the sector relative to the long-term of price, except for Sino Gas & Energy ((SEH)).
In investigating the potential for a government cap on premium rates in the health insurance sector, Credit Suisse suggests a 2% cap is not that significant for Medibank Private ((MPL)), nib Holdings ((NHF)) or even the industry.
The Federal Labour Party has indicated, if it achieves government, it would cap price increases for private health insurers at 2% for two years.
Credit Suisse is mindful that this is not a full policy change but a media release from an opposition and there remains a lot that needs to happen for such a policy to actually play out. In the meantime, there is upside risk to earnings as inflated profit margins can be maintained.
The absolute profit level to which potential downside risk is applied may be a lot higher than what current consensus forecasts assume, the broker asserts. Credit Suisse notes industry profit margins are at peak levels, at 5.5%, which has only been reached twice the past 10 years and is more than 20% above the 10 year average.
The profit margin is being held down slightly by the increase in management expenses in recent periods. The broker acknowledges the impact of 2% premium growth for two years will depend heavily on claims inflation.
On the broker's calculation the industry's net margin can be sustained above 3%. Lowering the premium rate increase to 2% would reduce the broker's net margin estimates in FY20 for Medibank Private by -6.5% and nib by -5.6%.
The move towards electrification of automobiles continues to enjoy tailwinds, as global carmakers release their hybrids, full electric models and global sales targets. Ord Minnett, which whitelabel's research from JPMorgan, envisages the recent sell-off in the lithium sector as an opportunity to buy quality assets.
The broker initiates coverage on Mineral Resources ((MIN)), Orocobre ((ORE)), Galaxy Resources ((GXY)) with Buy recommendations, Pilbara Minerals ((PLS)) with Hold and Kidman Resources ((KDR)) with a Speculative Buy.
Positive sentiment towards the lithium market and these equities has driven up asset valuations and rivetted the attention of industry players, downstream customers and global money managers.
The five companies mentioned have a combined market capitalisation of more than $8bn and control some of the highest quality lithium brine and hard rock projects in the world.
Despite recent share price weakness the broker believes these equities will remain in focus as the electric vehicle market develops. Galaxy Resources remains the sector preference, as it is the only independent supplier to the Chinese concentrate market.
Orocobre is the only global lithium pure play while Mineral Resources controls a tier-1 hard rock asset and has expressed an intention to integrate vertically to gain more battery exposure. Pilbara Minerals intends to expand its Pilgangoora project to become one of the largest hard rock operations in the world.
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