Weekly Reports | Mar 15 2019
Weekly Broker Wrap: telcos; building; diagnostic providers; casinos; insurance; and consumer stocks.
-UBS expects little improvement in mobile industry earnings and cash flow
-Construction materials sector retains a positive outlook
-Crown Resorts' Sydney casino could actually grow the gambling market, Credit Suisse asserts
-Local insurers could be vulnerable in home and motor markets
-Australian companies increasingly seeking to expand offshore
By Eva Brocklehurst
The main issues for the telecommunications sector in 2019 centre on mobiles and the NBN. In terms of mobiles, UBS believes revenue share has been the main goal of Optus and, significantly, the first half of FY19 was the first period in over three years in which the company did not materially grow its share of mobile revenue.
UBS estimates the company's share rose to 30.7% in the first half of FY18 but has been steady ever since. The offset was higher-value subscribers, causing a lift in mobile earnings. The broker wonders whether Optus may now be prioritising earnings and cash flow over market share.
UBS suggests mobile returns are attractive for Telstra ((TLS)), the number one operator, but much more modest for the number three, Vodafone Hutchison Australia. Little improvement in mobile industry earnings and cash flow is expected. Mobile revenue growth in the first half was misleadingly robust, UBS believes, as hardware revenues provided a substantial proportion of the growth and offer negligible margins.
The broker suspects one of the main reasons the ACCC approved the merger of Vodafone and Hutchison in 2009 was that these entities were unlikely to significantly invest in mobile broadband/network capacity on a stand-alone basis.
With current delays to the merger decision of TPG Telecom ((TPM)) with Vodafone Hutchison Australia the broker suspects a similar debate could be occurring at present, i.e. would a stand-alone TPG or Vodafone invest enough to be an effective competitor to Telstra and Optus?
On the NBN, UBS believes an eventual reduction in wholesale prices is the most likely outcome for the industry. Vocus Group ((VOC)) has announced it is prepared to cede NBN market share and prioritise yield and profitability, and the broker believes this is part of a wider strategy to prioritise fixed wireless products over the NBN.
UBS wonders whether the growth in non-residential and engineering construction can offset the fall in residential activity. Around 37% of Australian construction expenditure is on residential and housing approvals were down over the last seven consecutive months.
Boral ((BLD)) expects flat growth and Adelaide Brighton ((ABC)) envisages stable volumes. CSR ((CSR)) has reiterated guidance, and BlueScope ((BSL)) appears the only one expecting detached housing construction will moderate. Most expect infrastructure work to mitigate the housing impact in the short term, although the broker is less certain.
To offset housing declines, engineering work needs to grow by around 10%. Hence, UBS believes it is too early to become positive on the earnings trajectory, as the overall outlook for the Australian building materials volumes and prices remains weak.
UBS believes the latest review of diagnostic medicine carries downside risk for providers. Potential changes to referral criteria for several pathology and diagnostic imaging tests have been recommended.
The recommendations focus on reducing low-value testing in areas such as vitamin B12 testing, iron/folate studies, shoulder ultrasounds and lower back MRI. If implemented, UBS believes the changes could lead to a reduction in referral volumes for operators such as Sonic Healthcare ((SHL)) and Healius ((HLS)).
In assessing the impact of the Crown Resorts ((CWN)) Sydney casino when it opens in 2021, Credit Suisse concludes that both this property, and the new Star Entertainment ((SGR)) Sovereign Room, will grow the gambling market more than originally expected, estimating the premium mass market may grow 11%.
This means the revenue erosion projected for The Star may not be as bad. The broker models a -10% decline for premium mass and flat VIP revenue over FY21-23. On the other hand, Credit Suisse increases Crown Sydney's projected FY22 operating earnings (EBITDA) to $175m and then to over $200m in FY23.
The broker sees Star Entertainment as cheap, upgrading to Outperform from Neutral. The analysis provides improved confidence in the expansion of the Australian gambling market and this should drive the stock towards fair value. Meanwhile, Crown Resorts is considered fully valued and a Neutral rating is maintained.
Macquarie believes local insurers could be vulnerable in their most profitable home and motor markets as new entrants win business in the (supposedly) unprofitable broker channel.
Increasing pressure in the insurance broker channel could provide opportunities for insurers that are focused on the direct channel, as the cost bases of Insurance Australia Group ((IAG)) and Suncorp ((SUN)) are exposed.
A slowing economic cycle reduces new business volumes across the market and the broker believes both insurers will need to extend cost reductions to support margins. While expecting underlying margins will improve, Macquarie believes consensus expectations are elevated. The broker retains Underperform recommendations on both stocks.
Macquarie notes both companies have been losing volumes in the Australian home and personal motor markets and, unlike the prior decade where new entrants were intent on the direct channel, the latest entrants are homing in on the much maligned broker channel.
AIG has been underwriting mass-market home and motor products in Australia for the last 18 months while Blue Zebra (Zurich) and Chubb are also pushing into the mass market. Macquarie suspects these businesses will achieve scale quickly.
Morgan Stanley suggests, increasingly, Australia's consumer cycle is becoming less relevant, as a greater proportion of companies deploy capital offshore or export their premium brands. Also, structural pressures that have originated offshore, derived from Amazon and brands selling direct, are tending to drive trading multiples.
Morgan Stanley suspects Australian consumer companies will increasingly seek to expand offshore, given the relatively soft outlook for Australian consumption. Companies that have developed clear competitive advantages or unique products, such as Domino's Pizza ((DMP)), Treasury Wine ((TWE)), a2 Milk ((A2M)), Bellamy's ((BAL)) and Blackmores ((BKL)) have the best chance for success, in the broker's opinion.
Theoretically, these businesses should trade at a lower multiple, as earnings that are shifted offshore no longer generate franking credits, so the after-tax return to Australian investors is lower. Additionally, Morgan Stanley believes these companies should be less inclined to pay a dividend and implement more buybacks, as dividends from international earnings would effectively be double taxed.
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