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The Wrap: Banks, Slots, China And Contractors

Weekly Reports | Dec 07 2018

Weekly Broker Wrap: banks; slot manufacturers; China consumer; contractors; Alliance Minerals; and GR Engineering.

-Conflicting signals for Australia's banking sector
-Aristocrat Leisure continues to lead slot manufacturer performance
-New period of grace for cross-border e-commerce in China factored in
-Activity levels improve for contractor sector


By Eva Brocklehurst


Profitability across mortgage portfolios has improved. Macquarie reports the Lendi Mortgage Pricing Index shows owner occupier rates in November were around three basis points higher than the second half FY18 average.

This survey also indicates that while competition for owner occupier product is intense, banks have not passed on the full amount of re-pricing to new customers. Macquarie also notes the funding gap continues to widen as deposit growth moderates further.

Morgan Stanley is negative on major banks and expects growth to slow to around 2% in FY19 and FY20. System housing loan growth dropped to 5.3% in October, down from 7% a year ago.

While major bank growth is slowing in terms of owner occupier loans, it is slowing even faster for investor property lending. The broker suggests this is negative for bank margins, given lower prices and more front book competition in owner occupier loans.

Morgan Stanley believes the effect of restrictions on high debt-to-income customers and more scrutiny on income and expenses is now materialising. This underpins an expectation that major banks will continue to lose share.

In contrast, market share losses from the major banks are starting to abate, in Macquarie's opinion, and the slowdown in system credit growth is likely to be stemming from the non-banks implementing tighter lending standards.

Morgan Stanley points out system credit is a broad measure that captures business as well as corporate and institutional loans. The broker cites evidence that leverage to stronger business banking revenue has decreased for major banks in recent years, as they have skewed the business mix towards retail and mortgage lending.

Credit Suisse remains tactically constructive on the sector, believing the market is over estimating the structural impact of the Hayne Royal Commission. Together with margin benefits in the first half, the broker believes there will be a net benefit to earnings after an additional round of remediation in FY19.

This should mean the current -40% discount to the ASX industrials narrows. In the medium term, the prospect of a change in government is likely to limit a substantial re-rating of the sector, the broker suggests, until more clarity is forthcoming.

Slot Manufacturers

Macquarie has reviewed the performance of slot machine games within Australia over October. Overall, Aristocrat Leisure's ((ALL)) new games are performing 60% above floor average. The Dragon series leads performance across all states.

Meanwhile, games released over the last 12 months by Ainsworth Game ((AGI)) have performed below floor averages in October. Macquarie observes this underperformance continues to affect sales.

That said, the company intends to step up R&D investment, which the broker considers is a positive development although does not expect increased levels of product for 12-24 months. The ongoing outperformance of the Aristocrat land-based slot products in Australia makes Macquarie confident that a greater market share can be obtained in North America.

China Consumer

China's finance ministry has announced a new expanded list and extended the period of grace for cross-border e-commerce. The new list will be effective from January 1, 2019 and the grace period will be in place until March 31, 2019.

The list outlines goods that will be treated as personal items and, Citi notes, appears to include infant formula and a variety of health supplements, although it is currently unclear how this will apply to the broader health food category.

This indicates a lower-risk and longer-term policy than Citi had initially expected. Still, the introduction of a separate system for high-risk categories, such as infant formula and health foods, is likely over the medium term, as China clamps down on product quality and safety and promotes domestic consumption.

The period of grace has already been factored into relevant stocks but the longer-term policy alleviates earnings risk over the short term, in the broker's opinion. Still, further information is required as to how the list applies to the large number of units sold by Blackmores ((BKL)) and Swisse. Freedom Foods ((FNP)) is considered less exposed to the regulation as it operates in lower-risk categories.


Ord Minnett is generally positive on the contractor sector after meeting with a large number of companies in Perth. Activity levels appear robust and price rises are in train for some. Large iron ore projects have been confirmed for FY20 and beyond. On the negative side, labour cost increases remain a concern and conditions are competitive in some areas, which indicates margin expansion may be more limited and slower than the market expects.

The broker also noted generally supportive commentary for aftermarket activity and, therefore, puts Seven Group ((SVW)) at the top of its preferences in the sector. Still, following the voluntary administration by RCR Tomlinson, Ord Minnett is wary of owning contractor companies that are entering into material fixed-price contracts in new areas of work.

Those that are winning large amounts of fixed-price work in competitive conditions should be scrutinised, in the broker's opinion, considering the extra risk being taken on. Meanwhile, Austal ((ASB)) is experiencing opportunities with defence contracts and has highlighted new sites in Vietnam and the Philippines are offering more capacity.

Alliance Mineral

Canaccord Genuity initiates coverage of Alliance Mineral Assets ((A40)) with a Speculative Buy rating and $0.50 target. This follows completion of the merger with Tawana Resources. The company now has full ownership of the Bald Hill hard rock lithium operation in Western Australia, which has an initial reserve life of over nine years.

It was commissioned in March with initial spodumene concentrate production capacity of 155,000tpa. The broker also notes an opportunity to extend the mine life through infill drilling and/or conversion of inferred resources.

GR Engineering

Moelis initiates coverage of GR Engineering Services ((GNG)) with a Buy rating and $1.47 target. The contractor specialises in fixed-price, design and construction of mineral processing plants and mine infrastructure, in Australia and internationally.

While the broker expects FY19 earnings to be affected by the completion of a large contract in FY18 and a slower start to new projects, a recovery from the second half should be forthcoming. The broker believes the valuation and PE of 9.5x FY20 operating earnings (EBITDA) does not reflect this high-quality and high-margin business.

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