Weekly Reports | Nov 09 2018
Weekly Broker Wrap: health insurers; housing; automotive dealers; airlines; PRRT; Security Matters; and Netwealth.
-Catalysts ahead in private health insurance carry downside risk
-Household de-leveraging expected to restrain spending growth into 2019
-Headwinds persisting for automotive dealerships
-Woodside most affected by changes to PRRT
By Eva Brocklehurst
The private health industry is facing substantial challenges, with Macquarie assessing that over 85% of funds could have insufficient excess capital in order to sustain two consecutive years of a 2% price cap.
Margins in the largest states are improving but premiums per policyholder are increasing more in states where participation is slipping the most. The earnings gap between the for-profit and not-for-profit funds almost doubled in FY18, which the broker suggests raises the chances for different capital rules to be imposed.
The next catalysts for the industry carry material downside risks, Macquarie believes. These include the April 2019 price increases, first half earnings results and the outcome of the federal election, due by May 2019.
Current valuations appear supportive but the broker does not believe all the catalysts are completely priced into consensus estimates and maintains a Neutral rating for both Medibank Private ((MPL)) and nib Holdings ((NHF)).
While UBS assesses the insurers are in good shape it cannot say the same for consumers or hospitals. A soft claims environment appears to have continued into FY19, positively skewing the risk to margins in the near term, although the broker acknowledges the conditions are unsustainable over the medium term.
Medibank Private has made progress in stemming its market share losses but this could prove challenging, in the broker's opinion, should the tailwind from taking share from Bupa moderate. UBS retains a Sell rating on the stock with a Neutral rating for nib Holdings.
More broadly, the sustainability challenge is highlighted by the virtual absence of any growth in policy numbers. The broker also questions whether the historical margin cap of 5.6% will prove irrelevant in a soft claims environment.
While the broader economic impact of sliding house prices has been limited to date, Morgan Stanley believes household de-leveraging will restrain spending growth into 2019. National house prices are now down -4.6% in the year to date, nationally, and auction clearance rates and sentiment have also weakened sharply.
Surveyed house price expectations have now fallen to record low levels. Meanwhile, construction appears to be responding to weaker prices and tighter credit, with a declining trend in both apartments and detached houses.
A further consideration is the proposed changes to negative gearing and capital gains tax discounts being mooted by the ALP ahead of next year's federal election. Morgan Stanley assesses the policies as positive for affordability and negative for prices and turnover.
The broker considers the decline in house prices a catalyst for de-leveraging and a meaningful headwind for bank revenues and consumer spending. However this is not necessarily recessionary while global growth and public expenditure are supportive.
Australian car sales fell -5.3% in October 2018. All states deteriorated besides Tasmania. Passenger car sales continued to lead the decline, down -24% and partly offset by an 8% rise in sports utility vehicles.
UBS believes reductions in house prices are continuing to affect new car sales. When adjusting sales by each dealership over the 12 months, in each state, the broker estimates new car volumes over July-October, combined, were down -8.8% for Autosports Group ((ASG)) and -6.6% for Automotive Holdings ((AHG)).
The broker believes it will be difficult for Autosports to grow like-for-like volumes because of the macro outlook although, given the improving earnings and minimal exposure to flex commissions, estimates new car revenues could fall -5% and still hit FY19 estimates.
Meanwhile, Automotive Holdings has headwinds from its exposure to the slightly faster rate of decline in new car sales in Western Australia as well as the ongoing effects of regulatory changes that, UBS estimates, could reduce finance commissions by -25%.
Wilsons believes WA held up reasonably well in the latest figures as it cycled strong growth, albeit remains cautious about the near-term outlook for Automotive Holdings as there are no notable catalysts for a recovery in consumer activity in WA.
The broker downgraded its outlook for dealerships following the July figures and believes the latest three months justifies the revised outlook. Wilsons assesses conditions remain more favourable for AP Eagers ((APE)).
Domestic passenger growth for airlines slowed in September, with Sydney Airport ((SYD)) reporting a decline of -0.5%. Ord Minnett calculates, using bookings data from Travelport, that yields for Qantas ((QAN)) across key international routes were down -1.9% in August from a year ago. The broker notes Qantas reported domestic passenger yields increased by just 3.6% in the first quarter versus 7.0% in the prior corresponding quarter.
The broker admits the analysis focuses on just a handful of routes but believes both Qantas and Virgin Australia ((VAH)) are facing headwinds and a challenging operating environment a missed increased competition, weak demand, excess capacity and higher fuel costs. The broker has a Sell rating for Qantas and Lighten rating for Virgin Australia.
The Australian government has responded to the Callaghan review of the Petroleum Resource Rent Tax (PRRT), reducing uplift rates over the next 10 years to Long-Term Bond Rate (LTBR) +5% from the current LTBR +15% for all production licenses granted after July 1, 2019. Historical exploration will continue to be uplifted at the prior rate and switch on July 1, 2019 to the new rate.
The government will also remove the obligation for all onshore projects. Companies had been using onshore credits to reduce PRRT on profitable offshore projects. A 12-18 months review on how LNG projects use transfer pricing to reduce PRRT obligations will also be conducted.
Macquarie envisages Woodside Petroleum ((WPL)) will be most affected by the changes, as Scarborough could potentially lose -15% of its value and the impact could be even larger for Browse, as a compounding effect of the tax shield will be diminished with the project being further away from first production.
The bigger concern is the gas transfer pricing review, which could delay projects and potentially reduce future earnings. Oil Search ((OSH)) is unaffected by the changes as its operations are in PNG and the US.
The changes are relatively modest compared to what the industry feared, Credit Suisse points out. The broker envisages a negligible impact on Woodside's earnings, for the next five years at least, and no impact on the North West Shelf. The impact on Pluto/Wheatstone is expected to be limited and there is modest impact for Scarborough and Browse.
The changes do not materially affect the broker's base case valuation. Credit Suisse concurs that the transfer pricing review into integrated LNG projects remain a more material risk to the value of existing LNG projects.
Security Matters ((SMX)) has a technology which can be used to mark products during the packaging and production process. Such products can be tracked throughout the supply chain to the end customer.
TMT Analytics suggests, by invisibly marking branded products and packaging, product authenticity can be guaranteed by retailers, noting losses from counterfeiting alone are in excess of US$500bn globally. The company, an Israeli B2B business, recently listed on ASX and TMT Analytics values the stock at $1.13 a share, initiating coverage with a Speculative Buy rating.
Wilsons was concerned that the trading multiples of Netwealth ((NWL)) would not accommodate a broadening of price-led competition after BT Panorama cut platform administration fees.
However, the broker is increasingly of the view that incumbent platforms will need to open up to external providers to appease the Hayne Royal Commission. This would significantly increase the addressable market for Netwealth. Removing previous discounts leads Wilsons to double upgrade to Buy from Sell. Target is $8.49.
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