Weekly Reports | Sep 17 2021
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Weekly Broker Wrap: Patchy global recovery ahead, telcos tipped for special dividends, REIT upside realigns with fundamentals, Woodside to emerge as favoured MergeCo
By Mark Story
-Global indebtedness and wealth inequality have been reignited by the pandemic
-Proceeds of Telstra/TPG infrastructure sell-downs to return to shareholders
-Reopening story for large-cap mall landlords already priced in
-Post-merger, Credit Suisse expects Woodside’s Top 10 independent O&G status to attract global investors
Global economic recovery: Future rebound no longer in sync
While inflation fears and the delta variant have commanded the market’s attention recently, Oxford Economics' research suggests there are four key themes set to steer financial markets in coming months.
Firstly, while the onslaught of the pandemic set in motion the most synchronised global downturn and subsequent recovery in recent history, the forecaster expects the next phase of the recovery to be markedly different.
Oxford expects the patchy nature of the path to full recovery across western, Asian, and emerging markets to be exacerbated by ongoing disruption to supply chains.
Overall, Oxford expects supply constraints to contribute to the volatile nature of the recovery. The forecaster notes while supply issues have been a feature of past recoveries, they have not been on the same scale as the current disruption and foresees further disruption, especially if Asian countries struggle to cope with more covid waves.
Oxford also points to bloated global savings that have remained a present reality since the pandemic surfaced. While the pandemic has only galvanised policymakers’ desire for growth, the forecaster suspects the flipside to an eventual depletion of households’ excessive savings, will see a reversion to a grinding pace in 2023.
While an extended, rapid recovery from the pandemic may convince some that the market has unshackled itself from secular stagnation concerns, the savings glut remains embedded within the forecaster’s baseline assumptions.
The forecaster subscribes to the contrarian view that the long-term factors – indebtedness, demographics, and wealth inequality – that have depressed growth and inflation have in fact been reignited by the pandemic.
Thirdly, in the near term, the forecaster expects excess savings to underpin high asset price valuations. Oxford admits there’s limited likelihood of multiple expansion dampening returns. But barring a broader downturn, the forecaster suspects the risk of a significant correction in prices is low.
Regardless of central bank tapering, Oxford expects abundant liquidity that has supported valuations, to remain intact. The ensuing quest for yield and the high levels of capital looking for a home should keep valuations elevated relative to fundamentals.
Lastly, Oxford believes reduced living standards from high inflation, unemployment, and income inequality, together with the need to withdraw public sector support to address mounting debt, will lead to geopolitical risk. This risk will surface in the form of populist policies, especially within advanced economies and emerging markets.
Over time, Oxford expects the burden of fiscal adjustment hoisted on many countries by the pandemic, may well worsen the volatility of the recovery.
In conclusion, Oxford suspects economic underperformance in the years ahead only galvanises the base case for more combative international economic policies designed to source advantage from trade relationships. The forecaster’s analysis also suggests that the implications for decoupling on trade and productivity would be more detrimental for China than the US or other western economies.
Oz telcos: Two pending infrastructure divestments
The mouth-watering valuations achieved by both the sale of Vocus Group in its entirety, and a 49% stake in Telstra’s ((TLS)) TowerCo, has spurred companies across the sector to review the telecommunications infrastructure within their portfolios, with a view to boosting shareholder value.
In light of these developments, JPMorgan assesses two potential transactions currently under review: Firstly, Telstra's InfraCo asset, which operates passive infrastructure assets including FibreCo, and Ducts & Fixed Network Sites (DNFS) which reported earnings of $1.47bn, over six times that of TowerCo.
Based on the part-sale of TowerCo, JPMorgan values InfraCo at $31.7bn, representing a 21.6x multiple, and estimates a 49% sell-down would generate $14bn in value, after capital gains tax, which could be used to reduce debt and buyback stock.
The broker expects the likely timing of a potential transaction to occur late FY22 or early FY23, following the completion separating legal entities of the group. If the recent sale of TowerCo is any proxy, JPMorgan expects 50% ($6.8bn) to go to debt reduction, with the remaining proceeds from the transaction being returned to shareholders.
Based on the current share price, the broker estimates a $6.8bn buyback – assuming 49% sale after capital gains tax – would be up to 10-11% earnings per share (EPS) accretive while gearing would also decline to 16%.
Following the 49% divestment of TowerCo and InfraCo the broker estimates Telstra would need to buy back 1.4bn shares (12% of the register) to be EPS neutral in FY23. At current market prices, the broker notes this would result in $5.4bn allocated to share buybacks with the remaining $2.8bn being allocated to a special dividend.
Due to mobile margin improvement, cost reductions driving stronger fixed earnings, and potential for further asset monetisation, Telstra remains JPMorgan’s preferred stock and the broker maintains an Overweight rating and price target of $4.50.
Then there’s sell-down of TPG Telecom's ((TPG)) own tower assets, which JPMorgan believes could net the telco $1.3bn. Due to a higher tenancy ratio, JPMorgan expects TPG’s value per tower to be slightly higher than TowerCo and working backward from the average earnings per tenant from Telstra and Optus of $29,000, forecast overall earnings to be $63 million.
Assuming the transaction proceeds, the broker expects it to occur in 2022 following the review into the tower assets.
Given that TPG has recently completed a merger with Vodafone, JPMorgan expects the company to favour debt reduction and/or the return of proceeds to shareholders, over further M&A activity.
Based on JPMorgan’s numbers, the $1.32bn proceeds from the sale of the towers would be sufficient to purchase 11% of the register. Under this scenario, JPMorgan forecasts EPS to be 0-7% accretive and 11% accretive to the broker’s fair value.
Despite cost synergies from the merger with Vodafone, JPMorgan notes TPG continues to experience covid headwinds, NBN margin erosion, plus concerns around its mobile with subscriber decline and average revenue per user decline. As a result, the broker retains a Neutral rating and target of $6.85.
Oz property: Back to reality for retail REITs
Macquarie believes the recent share price movement of retail malls in the UK, EU, and US highlights outperformance based on announcements or expectations of re-openings, as opposed to the physical re-opening itself.
As a case in point, while US-based Retail REIT Simon Property Group significantly outperformed industrial REIT Prologis in January/February, up 32%, since then Simon Property Group has underperformed Prologis by -19%. The broker notes that this outcome was experienced despite heavily populated states like California, New York, Florida, and Texas all re-opening throughout this period.
REITs in the EU had similar experiences. For example, in the 30 days post the announcement of the UK roadmap, EU retail REITs UR Westfield ((URW)) and Klepierre) outperformed industrial REIT landlord SEGRO by 19%. Similarly, the retail REITs outperformed SEGRO for the 30 days after the announced French roadmap to re-opening in May.
However, 60 days after the full reopening of retail, retail REITs underperformed SEGRO by just under a third (-29%).
Closer to home, there could still be some upside in valuations for large-cap mall landlords once the physical opening of non-essential retail resumes in October/November.
However, in light of the offshore experience, the broker views this eventuality as more limited given Scentre Group ((SCG)) – Underperform and target price of $2.60 — and Vicinity Centres ((VCX)) — Neutral and target price of $1.66 — have already rallied on the back of a roadmap to re-opening provided by NSW, Victoria, and the federal government.
From here, Macquarie suspects outperformance will rely more closely on fundamentals, which in the broker’s view, will remain challenging. For example, Macquarie notes gravitating from pandemic to endemic means learning to live with the virus, which the broker suspects result in additional challenges for retail landlords.
Energy M&A: Will Woodside emerge as Australia’s favoured energy exposure?
While the proposed mergers of Woodside Petroleum ((WPL)) and BHP Group's ((BHP)) Petroleum division, and Santos ((STO)) and Oil Search ((OSH)), will transform Australia’s listed energy equity landscape, Credit Suisse’s analysis concludes that post-merger, Woodside may resurface as a viable alternative for energy exposure in Australia versus Santos.
As a result, the broker maintains an Outperform rating on Woodside (target $27.65), and Neutral ratings on Santos (target $6.98), and Oil Search (target $4.38).
The broker suspect both entities may reposition as a differentiated LNG weighted and Asia Pacific-exposed ‘mini majors’ on the global stage. However, Credit Suisse believes even more M&A may be required to properly compete in the international leagues.
But considering that it is likely to take greater prominence on a global level given the company’s scale, the broker suspects Woodside may present a more favourable proposition on valuation, political risk and ESG fronts. Credit Suisse data indicates Woodside has more favourable ESG metrics compared to Santos: -40% lower emissions intensity, and a -30% emissions reductions target by 2030 versus -26-30%.
As a result, Credit Suisse suspects there’s a risk of overall register churn from Santos into Woodside which may have greater appeal to yield investors.
Credit Suisse sees value in both MergeCos, but more so with Woodside given the company’s more favourable position across key metrics, plus the beaten up starting base relative to Santos, in which more upside is already priced in.
While register overhang poses near-term risk for both Woodside, and to a lesser degree Santos, Credit Suisse reminds investors of the potential ESG de-rating of the sector. Given that this appears to be undermining a strong LNG and oil price backdrop, the broker suspects it could trigger further register churn.
However, assuming the market's appetite for oil exposure over the coming 12 months is not going to improve, the broker sees a potential zero-sum game playing out between Woodside and Santos MergeCos for investors’ incremental investment dollars from later in 2022.
Despite the scale and ESG headlines, Credit Suisse sees joint venture alignment at Scarborough for Woodside, and Papua LNG for Santos, as the key merger drivers, potentially presenting value in excess of market expectations.
The broker suspects synergy upside is yet to be fully factored into share prices and sees scope for accelerated ‘energy transition’ themed investment – by Woodside in particular – post mergers, as balance sheet room becomes available.
While Woodside is pursuing a carbon farming-driven strategy to help establish a foothold in the hydrogen gas market, the broker notes that Santos has already embarked on a carbon capture and storage (CCS) dominated strategy.
But despite these ‘energy transition’ ambitions, Credit Suisse is reluctant to ascribe too much value to the carbon farming/CCS or hydrogen/renewable deployments, given what the broker regards as questionable economics under the current market conditions.
Based on what it knows right now, Credit Suisse believes Woodside’s merger synergy target of US$400m per annum provides more upside than Santos’s US$95-$115m pa. The broker also sees Woodside as presenting marginally better valuation than Santos, with a stronger balance sheet — 12% versus 30% gearing – a slightly higher earnings margin of 58% versus 56%, and a more favourable enterprise value multiple.
Credit Suisse also expects the consensus 2021 dividend yield of 6% for Woodside versus 2% for Santos and 3% Oil Search to also favour the Woodside MergeCo, assuming Woodside maintains a similar yield.
In summary, post-merger Credit Suisse expects Woodside to stand out again to international investors as the only top ten independent oil and gas company, which is heavily LNG and Asia-Pacific weighted. The broker suspects this could provide a favourable point of difference versus global peers.
By comparison, the broker is less confident that the Santos MergeCo will be able to attract significantly more additional international attention given Top 20 versus Top 10 scale, higher concentrated political risk, greater carbon intensity, and limited yield
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