The Wrap: Contractors, Financials & Accounting

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Weekly Broker Wrap: health care & the US election; contractors; financials; and accounting software

-Heightened focus on pharmaceutical, biotech as US election gets underway
-Oz contractor sector underperforms during the pandemic
-Variable outlook for diversified financials, negatives largely factored into banks
-Xero challenging Sage in the UK, most recommended in Oz
 

By Eva Brocklehurst

Health & US Election

Janus Henderson asserts the coronavirus pandemic has cast a more positive light over the US healthcare sector. The urgent need to define treatments has helped focus attention on innovation in the pharmaceutical and biotech industries.

Based on early data, a vaccine is expected to be approved by early 2021. While healthcare remains a key campaign issue in the upcoming US federal election, sentiment has improved and stocks in the sector have benefited as a result.

Janus Henderson notes the NASDAQ biotechnology index has gained 11%, nearly double the return of the S&P 500. In comparison, during the 2016 presidential election, biotechnology declined -12.5% while the S&P 500 gained 8.6%.

While the Trump administration has joined a case brought to invalidate the Affordable Care Act, the analysts note this appears to have been political theatre rather than a real policy initiative. Furthermore, Republicans have not crafted alternative legislation.

In terms of what would happen if the Democrat Joe Biden was swept to power, his plan to roll out a public health option could still face an uphill battle. The ability to push reimbursement rates significantly lower could be limited by the poor financial state of many not-for-profit hospitals.

While volatility in healthcare stocks is likely, and the market typically trades on fear of healthcare reform long before any concrete details, Janus Henderson believes neither side wishes to undermine pharmaceutical innovation. Ultimately a solution to limit out-of-pocket costs and improve access to medicine should occur, benefiting the industry in the long run.

Contractors

Macquarie observes the contractor sector has underperformed the ASX200 since the start of the pandemic, noting that Downer EDI ((DOW)) and Worley ((WOR)) actually outperformed as SARS was encountered and contained back in 2003.

The broker considers Downer EDI cheap, with exposure to a recovery post the pandemic and a solid customer base. Moreover, the company's move to a services business is working, with a lot more alliance-based contracts that reduce the risk profile.

Worley has equally good leverage to a medium-term recovery, and Macquarie notes the worst of capital expenditure reductions is being encountered in 2020. The main catalyst will be a stabilisation in the workforce and new contracts, particularly renewables.

Meanwhile for Monadelphous ((MND)), iron ore is now 32% of revenue and there is a healthy pipeline of work. The company also envisages margins can return to pre-pandemic levels of 6.9% although Macquarie is slightly less upbeat.

Seven Group's ((SVW)) WesTrac has outperformed, with new equipment contracts in iron ore and gold. While the WA market is strong, the east coast infrastructure market is likely to be flat as the broker notes project delays continue, although a $1.5bn stimulus should become visible in the second half of FY21.

For Cimic Group ((CIM)) the focus is on the negotiations with Elliott Advisers regarding the sale of 50% of Thiess. Macquarie has Outperform ratings for all contractors with the exception of Cimic, which is rated Neutral.

Financials

Shaw and Partners describes the QBE Insurance ((QBE)) first half result as "awful" as it featured a decline in the attritional claims ratio that is dependent on the company's determination of the impact of the coronavirus pandemic. In contrast, total claims substantially increased. Hence, the broker has a Sell rating.

A Sell rating is also pinned on Insurance Australia Group ((IAG)) with the share price getting close to fair value but not close enough. Suncorp ((SUN)), while not leading the market, is avoiding the calamities of the previous two stocks, Shaw and Partners asserts.

The broker expects continued improvement and retains a Buy rating on the stock. Suncorp is also Bell Potter's preferred regional/diversified financial, considered to have the best credit profile in the sector, given conservative policies and after the clean-up of the non-core bank several years ago.

Macquarie Group ((MQG)) is taking a cautious approach and its success is dependent on the state of the equity and debt markets. While the share price implies high expectations, Shaw and Partners points out this business has a habit of achieving. Macquarie Group is also Bell Potter's top pick among the financials.

Shaw and Partners asserts, if AMP ((AMP)) is not broken up, further declines in the share price are likely. Regardless, a Sell rating is allocated to the stock.

Challenger ((CGF)) faces shrinking margins and net outflows and is not considered cheap enough yet. Another Sell rating from Shaw and Partners. Yet, Citi believes Challenger, Neutral rated, offers considerable value, although acknowledges it requires 9% growth in retail sales to generate positive book growth in FY21.

The broker also assesses Janus Henderson ((JHG)) continues to trade on an inexpensive multiple but acknowledges investors may need stronger evidence of a recovery in flows before the stock can gain momentum.

Citi expects the market will await further developments with Perpetual's ((PPT)) acquired businesses before deciding on whether to back the transformation to a major skew to US equities and lower dividend pay-out.

For Computershare ((CPU)), Citi observes some promise in servicing delinquent loans post the pandemic, although this is likely to be a longer-term opportunity. While understanding the ASX ((ASX)) has many qualities, including relative defensiveness, Citi finds the outlook inconsistent with the current elevated multiple. The broker retains Sell ratings on the latter two stocks.

In the case of the major banks, the market is cognisant of the negatives and this is factored into share prices. Hence, the issue for Shaw and Partners is how much more deterioration will occur. In turn, this will be governed by how long the economic lockdown continues in Victoria and when state borders open.

Bell Potter asserts, if home and business loan exposure to Victoria is considered a risk factor, then ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) would be at the riskier end of the spectrum and Commonwealth Bank ((CBA)) at the lower risk end. Similarly, this is also the case in terms of exposures to hospitality, accommodation and property/consumption.

Accounting Software

UBS assesses the main impact of this year's pandemic, at least in the short term, is likely to be on non-subscription revenue for accounting software providers. Business closures over the next year could be around 50% above historical levels.

The broker has surveyed 240 accountants across the US, UK and Australia covering their views on accounting software for small-medium enterprises and the impact of the pandemic.

Intuit is dominating the US while disruptor Xero ((XRO)) is challenging Sage in the UK and is the most recommended brand in Australia. The survey also provided further evidence of cloud penetration growth.

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