Weekly Reports | Oct 18 2019
Weekly Broker Wrap: clothing; refinery margins; waste management; fund managers; platforms; utilities; and port volumes.
-Clothing consumption trends signal structural decline
-Consolidation likely to drive Australian waste management industry
-Momentum likely to continue for financial services platforms
-AGL & Origin benefiting from higher wholesale electricity prices
-Port movements in August at the weakest for 10 years
By Eva Brocklehurst
Morgan Stanley suspects clothing markets may be going into structural decline. Over the past 20 years, prices for apparel have fallen in developed markets and this has, to date, been offset by consumers buying larger quantities.
However, volumes appear to have peaked and prices are still falling. Even online clothing retailing in the UK appears to be going into decline. The broker assesses the world's leading retailers for apparel have, on average, experienced earnings downgrades of almost -40% since the beginning of 2016.
While the shift in channel to online is clearly unhelpful to volume consumption it does not fully explain the trend. The possibility exists that clothing purchases have now moved beyond utility, whereby most individuals in developed countries have more than they want or require and are therefore spending money elsewhere.
Clothing has become cheaper to produce, with Asia providing most of the clothing manufacturing globally. Morgan Stanley envisages scope for production to continue to shift from China to even lower-cost countries, such as Vietnam and Bangladesh. Moreover, technology could significantly reduce the amount of labour required to make clothing and keep prices on a downward spiral.
The broker suggests falling prices, static volumes and ongoing channel shifting make for a toxic combination and apparel consumption in developed markets may now have hit a ceiling.
Margins in refining continue to improve, which provides a positive bias to Morgan Stanley's earnings forecasts, although a large uplift is not expected for the September quarter.
This has been a trend with diesel throughout 2019 but now gasoline margins are also increasing. The broker suspects crude premiums have risen, which will offset some of the gains for both Viva Energy ((VEA)) and Caltex ((CTX)).
The large spike in gasoline margins has only occurred recently and therefore should become more evident in the December quarter if maintained. Caltex has guided for lower production from its refining facility in the second half 2019 which will limit some of its performance.
The key to the stock performance will be whether both these companies can show that retail conditions are improving.
Citi believes the long-run dynamics of the Australian waste management industry will be driven by consolidation and a need for increased waste processing and recycling capacity.
There are high barriers to entry being driven by licensing and compliance requirements while there remain prospects for further margin expansion. This should underpin double-digit earnings growth for participants, albeit revenue growth could moderate in FY20 as volumes soften and tailwinds from acquisitions fade.
Citi initiates coverage on the sector with a cautious outlook, awaiting further evidence that the passing through of costs has been effective. The broker rates Bingo Industries ((BIN)) Neutral/High Risk with a $2.40 target and Cleanaway Waste ((CWY)) Buy with a $2.40 target.
Fund managers revealed material net outflows in the September quarter. Magellan Financial Group ((MFG)) bucked the trend, Macquarie observes, delivering around $1.3bn of inflows in the quarter. The broker suggests market conditions were supportive for asset growth, albeit less so than in previous quarters. Market movements increased funds under management by 1-5% across the sector.
Nevertheless, the broker observes valuation support has emerged and while flow trends are clearly a concern, the recent de-rating has meant Perpetual ((PPT)) is upgraded to Neutral from Underperform. Given the relative valuation appeal of Pendal Group ((PDL)) and the potential for flows to improve it remains Macquarie's preferred exposure in the sector.
Morgans expects momentum on financial services platforms, Netwealth ((NWL)) and HUB24 ((HUB)) will continue through FY20, supported by adviser growth and increasing funds under administration per adviser.
The broker expects the downside impact from lower cash rates can be contained, although there is potential for heightened volatility around any decisions by the Reserve Bank of Australia.
Earnings on cash transaction account balances are the largest earnings risk and a challenge to sentiment, in the broker's view. At this stage, Morgans expects Netwealth will experience a limited impact from the latest official rates while the will be some marginal impact on HUB24.
Higher wholesale prices in the electricity market continue to benefit AGL Energy ((AGL)) and Origin Energy ((ORG)) and UBS estimates prices will average $91/megawatt-hour across the national electricity market in 2020 before declining to $77/megawatt-hour in 2021.
The broker estimates over 4GW of committed new renewable capacity will enter the market by the end of 2020, driving prices down, although this will be slowed by grid constraints.
Despite the market providing short-term price signals to encourage new investment in dispatchable generation, competing policy settings between state and federal governments are stifling investment decisions, in the broker's view.
The distribution between intraday electricity spot prices is expected to widen and this will result in volatility, headwinds for base-load generation as well as slow the impact of renewables in reducing average prices. UBS anticipates further headwinds for some renewable project developers until additional transmission capacity and a clearer pricing framework are implemented.
Container movements across Australia's four major ports declined -12.2% in August, the weakest monthly movement in 10 years. This was driven by a slowdown in imports and exports. The rate of export growth has slowed materially since the start of the first half FY20 with NSW heading the list. NSW container volumes declined by -16% and Victoria's by -8.3%.
Citi retains a Sell rating for Qube Holdings ((QUB)) and $2.70 target. The broker believes the current share price reflects high expectations for the Moorebank project and leaves no room for near-term operating weakness. The broker forecasts first half volume growth of 4.5% for the Patrick business and 3.5% industry volume growth for the operating division.
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