The Wrap: Weather, Chemicals & Pathology

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Weekly Broker Wrap: weather; chemicals; diagnostic services; infrastructure; and Gage Roads Brewing.

-Unseasonal weather driving outlook for consumer-exposed stocks
-Concerns rise regarding Chinese dumping of ammonium nitrate in Australia
-Robust pathology volumes in May but growth seen muted
-Infrastructure activity supporting Boral and Adelaide Brighton
 

By Eva Brocklehurst

Weather

The weather is an important driver of sales for several consumer-exposed stocks. Macquarie analyses if the unseasonal patterns in January-May will be positive or negative for the second half of FY18.

The number of days with above-average rainfall in Australia during this period was -20% lower than historical averages. Most major cities also recorded temperatures above 2017 levels as well as long-run averages.

Such weather is a determinant of the consumption of cold beverages as consumers purchase these increasingly on hot and dry days. This supports Coca-Cola Amatil ((CCL)) as consumers are likely to spend more time outdoors and consume carbonated soft drinks, as well as its other products such as bottled water and alcohol.

There is likely to be a tailwind for Super Retail's ((SUL)) sports & leisure segments although this is offset a little by Macpac, a beneficiary of cooler weather.

Meanwhile, Kathmandu ((KMD)) has used winter apparel promotions and camping and hiking products to help offset any negative impacts from unseasonably warm weather.

The weather has also affected Myer ((MYR)) as high-margin seasonal winter sales, uncharacteristically started before winter began. This has resulted in extra discounting in an attempt to offset weaker foot traffic.

Moving to theme parks, Village Roadshow ((VRL)) has revealed its Gold Coast properties were affected by low attendance because of the Commonwealth Games and a wet March. However, Macquarie notes there should be a modest recovery from a drier and warmer April and May.

Finally, around 67% of Treasury Wines' ((TWE)) vineyards were located in Australia in 2017 and the warmer than average temperatures should result in rapid ripening conditions and a condensed harvest. The company expects the 2018 intake to be above long-term averages.

Chemicals

CLSA finds accumulating signs the east coast explosives market is tightening. Import volumes have risen sharply but demand also rose 70% in the first four months of 2018. The broker considers this feature important, given the capacity that Orica ((ORI)) is commissioning, and the material re-pricing of contracts at Incitec Pivot's ((IPL)) Moranbah plant in 2019.

Ammonium nitrate imports increased to 67,000t in 2017 from 49,000t in 2016. The source of imports has also changed and China now makes up 50% of imports. CLSA notes the Chinese are accepting selling prices into Australia at lower levels than other geographies which supports concerns regarding dumping.

The rise in imports partly reflects delays at Yarwun and Burrup but if anti-dumping legislation is passed, CLSA expects a jump in import parity prices with domestic prices following suit. The broker has an Outperform rating and $20.70 target for Orica.

Citi observes the chemical sector has underperformed the broader market in the first half of FY18 and, in contrast, expects the underperformance in Orica, for which it has a Sell rating, to persist, as it is exposed to oversupplied markets.

The broker blames the company's Burrup plant for tipping the market into oversupply while faulty heat exchangers have now stalled the plant and minimal output is expected for FY18.

The broker points out Orica is re-starting mothball capacity at Yarwun and, once Burrup returns, a battle is likely to ensue as both the east and west coasts will be in oversupply. Citi expects further price pressures until market balances are restored in 2023.

The main catalyst overhanging the ammonium nitrate market, in Citi's view, is contract renewals for major coal miners. Moreover, escalating US-China trade tensions are a growing concern. To the extent this slows global growth, explosives demand may be hit negatively by reduced mining output.

In contrast, the outlook for fertilisers is more positive, in the broker's opinion, and supply growth is expected to lag demand for nitrogen markets, while phosphates appear to have bottomed. The broker prefers Incitec Pivot for its leverage to improved fertiliser markets.

Diagnostic Services

Pathology trends in May were strong and well above five-year averages. Credit Suisse also notes strong growth in cytopathology outlays, up 66%, likely to be the result of changes to the national cervical screening program.

The broker remains wary that relative softness in GP outlays may limit the extent of growth over the near term for both Primary Health Care ((PRY)) and Sonic Healthcare ((SHL)). Meanwhile, surgical volume growth weakened in May to 3.7% and most specialties grew below longer-term averages.

Longer-term drivers of demand for private hospital services are still in place, such as ageing and population growth, yet Credit Suisse believes it unlikely there will be a recovery in utilisation as long as affordability pressures move patients into the public system and the government retains little appetite to introduce meaningful reforms.

Infrastructure

Australia's infrastructure boom has produced record levels of activity and, combined with a housing market that remains strong, this is expected to support demand for materials. Morgan Stanley believes Boral ((BLD)) and Adelaide Brighton ((ABC)) are best placed to benefit.

Construction work in roads, subdivisions and bridges represents 35% of Boral's Australian revenue and, the broker estimates, 25-30% for Adelaide Brighton.

Work done for the March quarter increase 29% to $5.8bn.Future work also indicates a strong pipeline and is 30% ahead of levels in the December quarter.

Morgan Stanley believes Boral is the best way to gain exposure to the activity as its geographical skew towards the east coast means it can benefit significantly from the strong demand.

Gage Roads Brewing

Gauge Roads Brewing ((GRB)) will acquire Matso's Broome Brewing for $13.25m in cash plus a deferred consideration of up to $2.8m in cash or scrip. DJ Carmichael estimates the transaction will be 20% accretive in FY19.

The broker considers the acquisition carries low integration risk and is a good fit strategically. It should increase overall profitability and de-risk future earnings streams. DJ Carmichael has a Speculative Buy rating and 12.5c target.

The company is funding the acquisition via a $10m institutional placement which was oversubscribed. Gage Roads will also retain a three-year option to acquire the Broome-based brewery venue.

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