Tag Archives: Building Material & Const

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Weekly Broker Wrap: Reporting Season, Small & Mid Caps, Grocery, Tax And Apartments

-Trends best in domestic leveraged stocks
-3PL & AUB key performers in February
-Food imports surge with private label
-Uncertainty results from tax debate
-Strong apartment pipeline for 12 months

By Eva Brocklehurst

Reporting Season

So far, there are 42 large cap stocks which have reported this month, with UBS noting the season is around half way in terms of large caps and less than half way so for small caps. Reactions in share prices, despite the downturn in markets over the month, have been larger than the revisions suggest, but also skewed to the positive side, the broker observes.

In essence, there has been a number of large rises in share prices on results that were better than feared. The broker notes the trend has been reasonable for stocks leveraged to the domestic economy, particularly housing and consumer related stocks. Small caps have performed marginally better than large caps.

The performance from foreign currency earners has been mixed . UBS believes the market has oversold versus the earnings backdrop, particularly as far as the big banks are concerned.

The strongest results so far, in terms of the combination of share price reactions, earnings revisions and the broker's quality matrix, came from Boral ((BLD)), Cochlear ((COH)), Domino's Pizza ((DMP)) Star Entertainment ((SGR)) Amcor ((AMC)) and Orora ((ORA)). Most disappointing were Computershare ((CPU)), Tabcorp ((TAH)), Henderson Group ((HGG)), Aurizon ((AZJ)) and Ansell ((ANN)) (pre-announced).

Small and Mid Caps

Goldman Sachs removes MYOB ((MYO)) and Sai Global ((SAI)) from its Australian Small & Mid Cap Focus list following suspension of coverage. Fisher & Paykel Healthcare ((FPH)), Flexigroup ((FXL)) and Sky City Entertainment ((SKC)) are added.

The list is down 10.1% in February to date while the Small Ordinaries Accumulation index is down 4.8%, implying underperformance of 5.4%.

In the month to date the key performers were 3P Learning ((3PL)) and Austbrokers ((AUB)), which outperformed 10.1% and 5.1% respectively. Main detractors were amaysim ((AYS)), McMillan Shakespeare ((MMS)) and Blackmores ((BKL)), which underperformed 16.6%, 11.8% and 11.0% respectively.


Australia is increasingly relying on importing food. Food imports by value have risen at an 8.4% compound rate since 1988, with an acceleration to 10.2% since 2008, as supermarkets look overseas for cheap privately branded products. Morgan Stanley estimates that imports now represent around 19% of supermarket sales at retail levels.

A high Australian dollar and the increase in private label products is the driver of the acceleration, in the broker's view. Historically, the link between dry grocery inflation and the AUD/USD is strong but as the Australian dollar has weakened recently dry grocery inflation has declined, rather than increased.

This suggests to the broker that the industry is more competitive, with Aldi's share of the market now at 7.0%. Given low demand elasticities and low volume growth, the broker suspects pressures from declining dry grocery prices will be difficult to offset.

Tax Talk

Labor has outlined plans to limit negative gearing to newly built properties from July 2017, with any deduction from investment in established properties limited to investment tax liabilities. In addition, the capital gains tax discount would be halved for all investments.

Morgan Stanley believes the positives under the Labor proposal could include a pull forward of volumes as investors rush to beat the deadline, driving up prices and expanding margins. Also, the differentiation between new and established property would be a material new tax distortion which should incentivise higher construction volumes.

The debate is likely to continue until the government's position on negative gearing and the outcome of the federal election (at the latest January 2017) are known.

The Labor proposal challenges the government to deliver on its promised broad-based tax reform, Morgan Stanley asserts. Either way, change is coming and the impact on markets and at the macro level could be meaningful.

Oppositions over the past nine years have not been proactive in terms of policy. Labor's move may put the focus on tax in the government's re-election plans. It appears a rise in the Goods & Services Tax is now unlikely and the broker suspects the policy battle will be around the broad collection of investment tax.

The uncertainty is likely to weigh on financial services and housing related sectors. If the polls deteriorate for the government the broker observes the potential for another hiring and investment hiatus, as industry awaits to see what is actually implemented. In the context of already low growth, Morgan Stanley suspects this can only hinder second half earnings momentum.


Australian dwelling approvals signal a strong pipeline of construction projects for Boral and CSR ((CSR)) and various other building product suppliers, Credit Suisse contends. Looking at apartment approvals in isolation these are around 48% above the 10-year average.

The broker notes around half of the apartment style dwellings in the pipeline are in NSW, presumably Sydney. While there is little incentive for the major home builders to slow down, the broker notes that home builder pre-sales could be harder to achieve against a slowing Australian population and tighter capital controls in China.

The broker's base case for housing related building product volumes continues to be well supported for the next 12 months. A more protracted downturn is modelled for thereafter.

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Fletcher Takes A New Road

-Sensible and accretive, brokers maintain
-Improves potential in NZ contract wins
-Diversifies away from manufacturing

By Eva Brocklehurst

Construction conglomerate Fletcher Building ((FBU)) will acquire Higgins Group, New Zealand's third largest road construction and maintenance contractor.

Most brokers consider the acquisition is sound and the move was widely anticipated. The purchase price of NZ$315m was somewhat of a surprise to Morgan Stanley, given press reports were suggesting around NZ$100m back in October.

The acquisition multiple of 7.9 times FY16 earnings is larger than the broker expected, especially given Higgins was previously a private company. Still, Morgan Stanley accepts that in the context of Fletcher Building's enterprise value/earnings multiple of 9.3, the acquisition is adding to value. Applying the company's margins from its heavy building product divisions suggests to the broker there could be as much as NZ$10m in synergies being realised..

Management expects synergy benefits of $2m per annum, which Credit Suisse also considers conservative, given the road contracting and maintenance that Higgins offers should be enhanced by Fletcher's infrastructure business. It could also improve the prospects of Higgins winning the NZ Transport Agency contract.

Credit Suisse still expects, outside of NZ, that operations will continue to under-earn the company's cost of capital and the current stock price implies little long-term earnings growth.

Deutsche Bank believes the acquisition makes sense because of the strategic and complementary nature of the asset. FY16 guidance has been maintained at NZ$650-690m which the broker notes represents 13% growth on the prior year. The Higgins transaction will not be finalised until June 30 so will not be featured in FY16 results.

The proceeds from the sale of Rocla Quarry Products should enable Fletcher to satisfy around two-third of the Higgins acquisition price, brokers assert, without drawing down on its syndicated bank facility. Management also signalled, but without detail, that it remains interested in acquiring an integrated heavy-end Australian asset. Deutsche Bank observes there is one potential asset of this nature for sale, which it does not name.

The company announced a change to its segment reporting, separating the construction and property businesses into two units to reflect the increasing importance of the property division. The heavy and light building products are being combined, and roofing is being moved into the laminates and panels division.

Deutsche Bank observes this is the third change to segment reporting since 2012 and reflects changes to management. The broker also observes that Higgins Group is the only acquisition made since October 2012, when the current CEO commenced with the company. Since then four divestments have occurred, in addition to the closure of the Crane copper tube factory.

Higgins Group has three business divisions: Contracting NZ, Contracting Fiji and aggregates. The Fiji division complements Fletcher Building's existing South Pacific operations. Higgins is already a supplier to Fletcher's construction division for major infrastructure projects.

Higgins, therefore, fills a gap, in Macquarie's view. Road works are a reasonably large part of the construction market in NZ and Fletcher's existing business does not compete in maintenance. Macquarie suspects the company’s lack of presence in roads has been costing it a share of capital works.

Moreover, the acquisition helps the company to diversify away from its manufacturing base which has been losing market share across Australasia. Macquarie believes this situation is occurring because of a deteriorating cost/service position. The broker believes the re-shuffling of the divisions also underpins a desire to significantly increase the company's NZ residential building rate.

One aspect that surprised Macquarie was the importance of the Fijian market to Higgins. Credit Suisse also suspects Fletcher's construction business may provide a platform for Higgins to expand beyond Fiji in the South Pacific.

UBS likes the acquisition, given the natural synergies from vertical integration and the proposition of a combined entity when competing for tenders. The broker estimates Fletcher Building, post acquisition, will have a 45% market share in NZ capital works and 10% in road maintenance/asphalt. The broker believes Fletcher Building is arguably the best value in the building materials sector, once investors become more confident in the earnings projections.

There are four Buy ratings and two Hold on FNArena's database. The dividend yield on consensus FY16 forecasts for Fletcher Building is 5.4% and 5.9% on FY17.

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Weekly Broker Wrap: Hospitals, Insurers, Banks, Building Materials And Temple & Webster

-Caution urged on hospital sector
-Domestic insurer P/E discounts unjustified?
-Domestic bank provisioning on oil too low?
-Low oil prices support building products
-With most benefit attributed to Boral
-Temple & Webster well placed to grow


By Eva Brocklehurst


Utilisation has been the main driver of growth in the hospital industry, with Macquarie's analysis signalling the amount of hospital care per person received since 2005 has increased 41%, for those with insurance. Contrary to popular belief, the analysis points to ageing as only a small factor in this.

Are we receiving too much health care? The broker asks the question, given the federal government has initiated a review of the Medical Benefits Scheme fee schedule with a goal to link reimbursement to good clinical practice. Uncertainty exists as to the impact on the industry but Macquarie suspects it could be material and there is little appreciation of the current risk.

Hence, the broker urges caution on the sector until clarity is obtained. Macquarie prefers Healthscope ((HSO)) over Ramsay Health Care ((RHC)) based on valuation, given a larger brownfield pipeline and less exposure to France.


Softer premium rates flowed through to margin pressure in 2015 and investor expectations were lowered considerably for 2016. Nevertheless, Credit Suisse observes early signs of a recovery in premium rates. The broker believes a large price/earnings (P/E) discount is no longer justified for domestic insurers Suncorp ((SUN)) and Insurance Australia Group ((IAG)).

IAG offers earnings upside in the broker's opinion, and the potential for a capital return in coming years, while Suncorp offers valuation support and an earnings recovery, albeit delayed versus IAG.

QBE Insurance ((QBE)) enters 2016 with commercial line premium rates softening globally and the broker envisages downside risk to gross written premium, which will continue to pressure margins. From a low base, nonetheless, it offers dividend support as its equity raisings are near an end.

Morgan Stanley considers QBE has the greatest risk/reward outlook, offering the best earnings growth and an undemanding valuation, while IAG struggles for growth but offers resilience and potential P/E expansion. In terms of Suncorp, the broker believes downside earnings risk and weak franchise momentum overhangs the stock and it remains too early to become a buyer.

Banks & Oil

Major banks have around $31bn exposure to the oil & gas industry, Morgan Stanley contends and provisions appear low versus the levels reported by US banks, although the broker acknowledges the nature of the exposures is quite different.

Commonwealth Bank ((CBA)) and ANZ Banking Group ((ANZ)) are the most exposed of the four major banks. The broker's US analysts note Wells Fargo reports energy reserve ratios of 7.0% and energy provision levels are building.

In contrast, none of Australia’s major banks have disclosed stressed exposure or provisioning levels in their oil & gas portfolio. The broker doubts provisioning levels on the mining books would be much above 1.0%. At the very least, Morgan Stanley expects the decline in the oil price will lead to pockets of weakness and higher-than-expected loan losses in FY16.

Building Materials

Credit Suisse looks at the implications of a low oil price environment on the building sector. The two most exposed stocks are Boral ((BLD)) and James Hardie ((JHX)). The broker concludes the current oil price environment is positive for the former and net negative for the latter.

Lower diesel fuel costs which directly reduce costs associated with concrete, asphalt and quarry trucking benefit Boral and, in addition, this should flow through to freight rates for other building products.

The lower cost of gas should also help with the manufacture of James Hardie's key product, fibre cement. The negatives for James Hardie lie in the sharp drop in oil sector employment in the US states of Texas and Oklahoma, key home building markets for the company.

UBS notes US housing is growing at a steady pace, even in Texas, and a lower Australian dollar traditionally favours building materials companies so, while the housing downturn will hurt this is not a typical cycle and companies are well prepared.

The broker finds CSR ((CSR)) significantly exposed to a housing downturn amid ongoing concerns over the future of the Tomago aluminium smelter. UBS highlights news that Fletcher Building ((FBU)) is close to acquiring the Higgins group in New Zealand, which will increase its exposure to construction contracting and mark its entry into asphalt and road surfacing.

Boral's progress in the US, and any comments around cement and concrete pricing, is expected to drive sentiment during reporting season and UBS still believes the stock provides the best overall risk/return investment proposition on a three-year view.

The broker has recently upgraded James Hardie to Neutral from Sell, as the price versus growth trade off appears more reasonable. Reporting season for Adelaide Brighton ((ABC)) is expected to be steady as she goes, with UBS not envisaging much new investment opportunity.

Temple & Webster

Temple & Webster ((TPW)) is Australia’s largest online specialist in furniture and homewares, operating three e-commerce platforms which attracted a combined audience of 12.6m visitors over the year to June 30. Bell Potter has initiated coverage of the stock with a Speculative Buy rating and $1.30 target.

The broker's positive view is predicated on the large growth potential for online penetration of the segment, with the company having a strong competitive position and multiple growth avenues, as well as a data-driven advantage.

The sites' categories have a relatively low level of branded goods and a wide range of unique products which reduce the tendency of consumers to check around for prices, Bell Potter maintains.

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Weekly Broker Wrap: SMSFs, Franking, Building Materials, Bank Capital, Wealth And Utilities

-Self managed super growing strongly
-James Hardie constrained by Texas
-Boral supported by Oz infrastructure
-Revised Basel rules but uncertainty prevails
-Fund flow growth slows but still healthy
-Policy uncertainty a headwind for utilities


By Eva Brocklehurst

Self Managed Super Funds

Self Managed Super Funds, or “selfies”, have had a torrid time this year, Credit Suisse maintains. They are on track to record capital losses for the third quarter in a row. As a consequence, selfies as a proportion of the $2 trillion Australian pension pool are reducing.

While there were comparable dollar losses in the rest of the superannuation fund segment these were smaller as a proportion of total assets. Allocations to Australian equities by selfies have fallen to 39% of current portfolios from 41% a year ago.

Despite this fact, the broker notes they remain the most important pension investor in Australian equities, owning 16% of the market versus 11% for retail funds and 7.0% for industry funds. Importantly, selfies are growing in numbers as members roll over funds from other superannuation vehicles.

The broker observes this will continue as the country's pension scheme ages and selfies will underpin the dividend trade in Australia. They are committing more new money to Aussie equities than any other group and the segment is winning new members at the expense of the rest of superannuation industry.

Their second biggest asset is Australian cash at 27% of assets under management and the third is Australian property, at 25%. Credit Suisse estimates their property positions have increased by two percentage points over the past 12 months.


Macquarie has analysed its data and research on franking, comparing companies against sector peers and looking at franking credits as a percentage of market capitalisation. Fortescue Metals ((FMG)) has moved into the top five in terms of the highest franking credit balances while Commonwealth Bank ((CBA)) has fallen in rank, albeit still increasing its franking balance to $569m this year from $533m last year.

In the lowest value end of the scale, Village Roadshow ((VRL)) has moved into the bottom five while Aurizon ((AZJ)) has come out. Aurizon's franking balance has moved from negative to $76m.

Macquarie also notes Harvey Norman ((HVN)) continues to have a high franking account balance compared with other companies in the ASX100, although its balance has dropped in 2015 to $584m from $659m. Fairfax Media ((FXJ)) has a comparatively low franking balance which has gone backward since 2013 when compared with other stocks in the ASX100.

Building Materials

Credit Suisse has surveyed US real estate agents and notes their concerns around the shortage of quality homes amid buyer resistance to higher prices. Home buyers constrained by job security were sharply in evidence in Texas, while several markets noted a material slowing in foreign buyers, which has taken the heat out of the market.

The broker believes this warrants caution around the broader housing market as the slower winter months get under way. This could be aggravated by affordability issues following recent increases in mortgage rates.

Texas accounts for around 25% of James Hardie's ((JHX)) total US fibre cement volume and is also one of the company's more profitable regions. James Hardie is also is overweight in the city of Houston, where activity according to the survey fell to its lowest level since the global financial crisis.

Credit Suisse expects the stock to be range bound until the secular growth story is restored. The company is also further impaired by a capital management story that has largely played out.

The broker estimates 20-25% of Boral's ((BLD)) US revenue is derived from Texas, accounting for 2-3% of the group. Still, a number of catalysts should support the company's earnings, with the broker anticipating the emerging Australian east coast infrastructure cycle.

Bank Capital

The latest Basel revisions to bank capital rules appears to be softening relative to last December's proposal, Macquarie observes. Uncertainty surrounding implementation and interpretation continues but the broker suspects risk weighting on standardised mortgages is likely to be lower than previously expected.

The broker also observes that while banks took the opportunity to raise pricing on investor portfolios relative to the owner occupier part of their book, the capital backing for these exposures has not materially changed.

Assuming regional banks are able to continue to utilise the lender mortgage interest capital offsets, Macquarie considers the revisions are a better-than-expected outcome for the regional banks. The broker continues to envisage upside risk to bank valuations as the sector yield gap to the industrials narrows.

JP Morgan considers the revised proposals maintain the pressure on the major banks to progressively build capital over coming years. The broker observes some headwinds across the corporate and credit card book but the biggest unknown is with mortgages.

Significantly higher risk weights for investor mortgages should be a key swing factor that the broker believes is open to interpretation on the basis of whether loan servicing is materially dependent on rental income.

The broker envisages overall risk weights across the regional bank portfolios as unchanged, with higher investor risk weights offset by lower owner occupied risk weighs for higher loan-to-valuation ratio mortgages.

The risk weight floor for advanced accredited banks for investor mortgages still largely remains an academic exercise, in the broker’s view. JP Morgan works with an assumption of an 80% floor.

Wealth Manager Retail FUM

Statistics from the September quarter indicate that weaker markets are affecting investor appetite, although UBS observes net inflows to wealth manager retail funds remain at quite healthy levels.

Flows have now remained at around $20bn for nearly two years and, as a consequence, growth from flows into funds under management (FUM) has declined to 3.1% from 3.8% over this period.

This level of flow was not sufficient to offset the impact of equity market declines, which reduced FUM by 2.0% in the quarter. While not the best quarter for AMP ((AMP)) the stock remains the broker's preference as a defensive wealth manager, versus pure-play fund managers such as BT Asset Management ((BTT)), as it is considered to have more leverage to reduced investor flows and markets.


Morgan Stanley believes the climate agreement in Paris has a low immediate impact on Australian utilities because the agreement was well flagged by the US and Chinese delegations, and because implementation in Australia will only follow in 2020.

The broker expects Australia's emissions reduction will require an evolving of the government Renewable Energy Target (to be reviewed in 2020) and its Direct Action plan. In the meantime, uncertainty in emissions reduction policy will be a sector headwind, in Morgan Stanley's view, as it hampers capex planning for the utilities under coverage. This contributes to a Cautious industry view.

DUET's ((DUE)) Energy Developments business is a beneficiary because its revenue and development prospects rely, in part, on emissions reduction policies. The broker's base case is a modest carbon price from the early 2020's, continued deployment of both large and small scale renewables and an orderly shift in the mix of coal-to-gas-to-renewables in thermal generation and oil-to-electricity in transportation.

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Weekly Broker Wrap: Aged Care, Consumer Electronics, Housing, Tourism And El Nino

-Short-term funding risk in aged care
-Dick Smith woes unlikely to spread
-House building firm despite affordability decline
-Bright outlook for tourism with AUD decline
-Extreme weather supporting electricity demand


By Eva Brocklehurst

Aged Care

Operating conditions appear sound in aged care, featuring high occupancy and rising bond inflows supported by a buoyant property market, in Deutsche Bank's observation. Still, funding reforms overshadow the sector. The broker believes the over-run relative to budget estimates makes it a priority for the government to address the issue.

Hence despite other attractive elements in the sector, the broker has downgraded Estia Health ((EHE)) and Regis Healthcare ((REG)) to Hold from Buy and Japara Healthcare ((JHC)) to Sell from Hold. The reflects adjustments to forecasts to allow for the impact of a freeze on aged care funding indexation from early 2016.

UBS also observes the short-term funding risk for residential aged care but suspects the impact on earnings will be contained to 2-3% at the bottom line. The broker believes if the government were to freeze indexation, currently at 1.3%, that would go some way towards addressing the gap. The government's Mid Year Economic and Fiscal Outlook (MYEFO) due next week may present a possible timetable for any changes.

Consumer Electronics

The efforts to clear excess inventory began in earnest late last week at Dick Smith ((DSH)). Deutsche Bank conducted a number of store visits to get some idea of what was being moved and the depth of discounting.

The majority of products were private label accessories, particularly under the MOVE brand. A large amount is aged with the majority of promotions on accessories to suit superseded hardware. The broker has also observed the depth of discounting is more aggressive in New Zealand.

UBS observes a difficult few months in store for Dick Smith but suspects the risks for the sector are overplayed. An irrational competitor with a 6.0% share does create a risk, nevertheless, and UBS suspects a 30 basis point impact to gross margins for JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)), which would translate to a 3.0% and 1.0% negative impact on first half earnings respectively.

The issue highlights the strength of the JB Hi-Fi and Harvey Norman brands which suggests to UBS a significant opportunity exists over time to take market share from Dick Smith. The broker retains a Buy rating on Harvey Norman and upgrades JB Hi-Fi to Buy from Neutral.


Deutsche Bank expects growth in FY16 housing starts of around 6.0%, with NSW and Victoria being the drivers partly offset by weaker conditions in Western Australia. Investor finance now represents 73% of total loan values in Australia versus the historical average of 47%, the broker observes.

In contrast first home buyers represent 12%, down from the peak of 29% in October 2009 and from the historical average of 19%. The broker notes some investors may be first home buyers but this is difficult to quantify with certainty.

Nevertheless, home affordability remains below historical averages for all states except Western Australia and Queensland, although the broker does not believe this is at trough levels in any capital city. Housing is expected to remain robust over 2016, with no change to the official cash rate until December next year.

Beneficiaries of this robust environment, in the broker's view, include CSR ((CSR)), although aluminium is a detractor for the stock, Fletcher Building ((FBU)), given its exposure to robust markets in both New Zealand and Australia and Boral ((BLD)), in a strong position given 30% of its sales relate to Australia housing. Deutsche Bank retains Buy ratings on all three stocks.


The Australian dollar depreciation has marked an end to cheap overseas holidays, UBS notes, with international travel prices at a record high. While the level of departures is still 25% above arrivals, net arrivals are the best since 2000, which provides some support to consumption, UBS observes. The broker expects, in a subdued economy tourism, at 6.0% of GDP, is likely to become a bright area in 2016.

UBS also expects the Australian dollar to fall to US68c in 2016 as the US Federal Reserve hikes rates and commodity prices remain soft. A lower Australian dollar is expected to underpin strong growth in tourist arrivals, supported by scheduled increase in international airline capacity of 8-10%.

El Nino

Morgan Stanley's El Nino update suggests, thus far, there is an impact on average electricity pool prices. Year-to-date average pool prices are higher in both NSW and Victoria. AGL Energy ((AGL)) is the most leveraged to pool prices, the broker notes.

That company has argued a structural rather than a cyclical view on prices, based on re-pricing of coal and gas supply contracts. Morgan Stanley, however, suspects a cyclical impact. Low rainfall has curtailed Tasmanian hydro production and hotter southern weather means lower demand-coincident wind production in South Australia.

Extreme weather tends to support electricity demand although, longer term, the analysts envisage declining demand and a dampening of prices amid new entrant renewables.

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James Hardie Misses Targets, Again

-Questions over 35/90 strategy
-Will it be margins or share that give?
-Lack of clarity on market penetration
-Yet US market growth remains solid


By Eva Brocklehurst

James Hardie ((JHX)) missed US market penetration targets in its first half, one of the levers for growth it outlined in previous presentations. The company has downgraded FY16 earnings guidance to a lower range of US$230-250m from US$240-270m and attributes this to soft volumes and a flat patch in growing market share.

This complicates its investment appeal, Credit Suisse observes. Growth in earnings is likely to be solid over FY16-18 but the lack of market share expansion raises a question over its 35/90 strategy. This so-called strategy involves an aspirational target of 35% fibre cement product share of the cladding market while growing James Hardie's share of that market to 90%.

Credit Suisse acknowledges there is no quick fix and the stock could be range-bound until confidence in the growth story is restored on that front. In the broker's opinion, the investment case is also impaired by the capital management story largely being played out and any premium ascribed to the stock in this regard may unwind.

A lack of growth in the second quarter suggests to Credit Suisse that the easy wins have been made in terms of market share for the company's fibre cement product, that competes with vinyl siding in the US. Further investment is probably required to accelerate growth. The broker acknowledges some concerns that weakness in housing activity is creeping into the renovations market but finds scant evidence as yet.

The broker does highlight that James Hardie appears to be adopting a more flexible pricing strategy, guiding for no price hike in March 2016 and flat net average prices over the next 18 months. A similar strategy was adopted in FY12, Credit Suisse observes, and was successful. The challenge is, therefore, how long short-term margins can be sacrificed for long-term gains.

UBS estimates the market is currently pricing in volume growth in new housing of roughly 20% in FY17-18, versus its expectations of a more sober 11-15%. This implies either an improvement in housing starts is needed, or that the company penetrates the market more strongly over that period. This broker also questions whether the 35/90 strategy is on track.

The broker's Sell rating is based on belief the market is too optimistic about this strategy. UBS believes it unlikely that 90% share can be achieved and high margins maintained. It's either one or the other. The path to the 35% fibre cement share of the cladding market is also not without obstacles. Substantial inroads into vinyl and wood are needed.

Back in Asia Pacific James Hardie's earnings rose 19%, underpinned by volumes as well as prices. This highlights the company's ability to drive margin growth despite production inefficiencies and procurement headwinds, in Credit Suisse's view. The broker expects that, if a favourable product mix continues, the drag on production at Carole Park diminishes and the US dollar stabilises, then margins could increase to over 25%.

While expectations have softened, Macquarie is not so worried, given the ongoing recovery in the US market. While the company has not worked its buy-back in the last quarter the broker notes it remains the preferred method of capital return and the second half typically provides more opportunity to execute on such activity.

In terms of the competitive dynamics, Macquarie notes rival Louisiana Pacific's siding volumes fell 14% in the last reported quarter so US volume growth of 7.0% for James Hardie compares well on this measure.

As for market penetration, it remains unclear to the broker as to which material is gaining share, whether it be vinyl, stucco or brick. Nevertheless, Macquarie acknowledges James Hardie's focus is on displacing vinyl siding and this has stalled over recent quarters.

Deutsche Bank is confident that the company's track record in turning around problem areas will stand it in good stead and it can again grow market share in fibre cement. It may take several quarters, nonetheless, to lift primary demand growth in both the US and Europe back to targeted levels.

The downgrade and lack of a price increase forthcoming in March surprised Morgan Stanley. The broker is also uncertain as to why unit costs increased in the second quarter, although this is a volatile item on a quarterly basis.

A weaker market rather than market share losses have driven the volume outcomes in the second quarter, Morgan Stanley believes, and any indication of a normalising of market demand would be taken positively.

Furthermore, the broker finds it difficult, on analysis of competitor business, to assess where market share in cladding has gone, suggesting this may simply be de-stocking rather than any large recovery in vinyl demand. Further details are sought from the next quarter's data, to obtain a read on whether any new trend is forming.

JP Morgan was disappointed in the results and, while the weaker margin performance can be explained away, the most pertinent issue is the stalling of primary demand growth. Acknowledging management's competence, the broker suspects this may be a deeper issue and have a longer time frame to resolution.

There is no expectation for primary demand to improve beyond being "flat", the broker observes, and downgrades its rating to Neutral from Overweight.

The downgrade to earnings forecasts has pushed Citi the other way. The broker upgrades to Buy from Neutral. Citi envisages there is much more to come from the US housing market cycle and remains confident in the company's intentions and ability to restore primary demand growth. The ensuing share price weakness after the forecast downgrade has delivered a buying opportunity, in the broker's opinion.

FNArena's database has four Buy ratings, two Hold and one Sell. The consensus target is $18.45, signalling 10.8% upside to the last share price, and compares with $19.62 ahead of the update. Targets range from $16.45 (UBS) to $20.50 (Macquarie).

See also, What Will Drive Growth For James Hardie? on September 14 2015.

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CSR’s Outlook Dulled By Glass And Aluminium

-Improved building product margins
-Viridian still lacklustre
-Aluminium under a cloud
-Dividend increase seen likely


By Eva Brocklehurst

CSR Ltd ((CSR)) beat expectations in its first half results but brokers remain divided as to just how long the housing cycle can underpin robust earnings growth. Strength in the building products division was generally unsurprising, as Australia is in the midst of a housing boom and CSR's products are mainly directed to housing.

Deutsche Bank is optimistic that a significant improvement in building product margins will mean upgrades to FY17 as well. The broker currently factors in 13.5% for FY17 building product margins, which compares with the 12.2% witnessed in the first half results. Upside to these assumptions is also considered possible, given product price increases of a similar magnitude are expected next year.

JP Morgan was also encouraged by the company's focus on operating efficiencies, with expectations of price increases and operating improvements driving its forecasts for margin expansion.

The first half may have beaten expectations in terms of building products but Viridian earnings (glass) were below Macquarie's estimates. While aluminium performed well, the outlook is challenged in the broker's opinion, and caution prevails as the company is still working on a deal for electricity pricing at the Tomago smelter.

Macquarie suspects price growth is lacklustre in building products, while still slightly ahead of cost growth. Outside of the bricks market, pricing power seems limited, with builders suggesting higher utilisation of plasterboard may bring price growth but the broker considers, for the rest of CSR's products, the outlook is mixed.

Estimates for FY16 and FY17 are revised higher, by 9.0% and 7.0% respectively and Macquarie believes FY16 will represent the peak in earnings. Moreover, housing approvals will increasingly become a headwind next year. A rapid decline in approvals and commencements is expected, starting in 2016. The broker has an Underperform rating and would use price strength as an opportunity to reduce its exposure to the stock.

The company may be generating cash and capital management is not out of the question, likely in the form of dividends. Nonetheless, Macquarie suspects a growth acquisition will be hard to come by and organic options are limited.

Citi is much more upbeat on this aspect, suspecting several options will be presented to the company amid an extended earnings cycle and cash flow that goes beyond dividends, such as mergers, acquisitions and capital management.

UBS is also positive, observing the company has made efforts to differentiate its business via small acquisitions that have had higher-than-average growth. Cost cutting has helped in aluminium and glass and a lower Australian dollar will be supportive. While all those aspects are pleasing the broker acknowledges the potential for a downturn in housing and aluminium prices.

UBS observes that in building materials, high multiple stocks which have growth are often preferred to those considered cheap but ex growth. Lead indicators are indeed what the market outlook relies on and the broker suspects CSR may continue investing to attempt to outperform the cycle. Also, the downside may already be priced in and there is the prospect of capital management, given a growing cash balance.

The most disappointing aspect for UBS was still Viridian. The broker suspects that an eventual housing downturn could make profits in this division sub optimal.

Morgan Stanley weighs in on the downside in terms of risks to the stock over the medium term. For now, the dividend yield is protecting the downside but the stock is not considered overly cheap.

At the current share price the broker estimates the market is valuing the building products division at around 12.6 times FY17 earnings forecasts. As this is expected to be the peak earnings year, this is considered a fair multiple. In the absence of a rally in the aluminium price Morgan Stanley expects FY16 is likely to be the peak for earnings in that division.

For Credit Suisse, the clouds hang over aluminium. Lower costs appear sustainable but the Tomago electricity contract remains a key area of uncertainty and one where the broker questions whether a better contractual outcome is achievable.

In terms of capital management, CSR is restricted by the asbestos liability on its balance sheet and, against this backdrop, Credit Suisse doubts it can explore special dividends and/or share buy-backs. The broker does highlight that the dividend pay-out in the first half of 63% was below trend and increasing it to the top of the company's pay-out target, at 80%, would represent a material increase from current levels.

FNArena's database has four Buy ratings, two Hold and one Sell. The consensus target is $3.57, suggesting 16.3% upside to the last share price. Targets range from $2.74 (Macquarie) to $4.25 (UBS). The consensus dividend yield on both FY16 and FY17 forecasts is 7.6%.

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article 3 months old

Wesfarmers Upholds Resilient Outlook

-Bunnings resilient to housing downturn
-Coles likely winning share
-But food deflation accelerates


By Eva Brocklehurst

Conglomerate Wesfarmers ((WES)) sustained a strong September quarter for its retail businesses. Brokers note even Target, which has struggled for some time, appears to have turned around.

Overall, sales grew by 6.5% ex petrol, and this should allow Wesfarmers to invest in prices and maintain healthy margins, Deutsche Bank maintains. Home improvement (Bunnings) impressed the broker as that division's sales rose 8.2%, cycling similar growth in the prior corresponding quarter.

Percentages may ease in future, the broker suspects, given the level of market penetration. Trade accounts appear to be making up a larger proportion of sales at Bunnings now and this suggests to Deutsche Bank the business could become more volatile.

What about the slowing housing construction outlook? Brokers are not that perturbed, given the market share Bunnings holds. Credit Suisse suspects the future of competitor Masters, owned by Woolworths ((WOW)) is the main variable for Bunnings.

The broker suspects closure of the Masters chain would be a benefit to Bunnings, while a change in ownership and strategy on the back of an exit by Woolworths could produce the reverse. Macquarie dismisses the slowing housing outlook, citing the resilience of Bunnings and lack of competition if Masters is wound up.

A new spurt of growth was evident at Kmart, as the chain expands its range. Citi suspects one third to half of the Kmart sales growth in the quarter emanated from the problems that competitor Big W (owned by Woolworths) endured in its inventory systems.

Target also recorded its first quarterly sales growth in several years, with fewer mark downs in the quarter. Credit Suisse considers this development validates the re-positioning of the Target image. While it is early days, Deutsche Bank also believes Target is showing promising signs.

Meanwhile, food price deflation has increased to 1.3% in the quarter, its highest rate in two years, which highlights the prospect that profit growth is slowing for Coles. In the absence of sales figures from Woolworths, Deutsche Bank highlights the difficulty in determining the extent to which Coles has outperformed.

Still, there are signs Coles gained considerable market share in the quarter. Morgans is confident Coles is winning the battle in the supermarket arena and it should deliver reasonable sales growth, even during a period of structural change and competition in the industry.

Brokers also believe the performance of Coles has been boosted by the weak performance of Woolworths. The higher level of price deflation signals the likelihood that margins will continue to compress across the supermarket industry as players increase their levels of price investment. In this regard, Morgan Stanley forecasts Coles earnings margin to compress to 4.7% in FY20 from 5.4% in FY15.

Goldman Sachs makes the observation that there was no comment from Wesfarmers on the impact that price competition was having on margins. Downside risks that Goldman Sachs contemplates include a resumption of "price wars" in groceries and a successful turnaround for Masters.

Goldmans, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating and $50.50 target for Wesfarmers.

Most brokers expect the slowdown in two key divisions - food and home improvement - will limit upside for the share price. Several consider Wesfarmers a good business with strong management but fair value.

JP Morgan believes the modest valuation support and no imminent change in the portfolio, with a lack of impetus in the industrial divisions, means the share price is likely to remain range-bound.

Citi suspects that some of the sales growth in the quarter is largely a reflection of less stable rivals. The broker questions the price being paid for Wesfarmers' growth and sticks with a Sell rating.

Morgans, on the other hand, believes the premium to Woolworths is entirely justified and the stock offers an attractive mix of reliable earnings growth and yield. Hence the broker retains an Add rating.

FNArena's database has two Buy ratings, six Hold and one Sell with a consensus target of $41.74, suggesting 0.4% downside to the last share price. Targets range from $35.80 (Citi) to $45.08 (Macquarie). The consensus dividend yield on FY16 and FY17 is 5.0% and 5.3% respectively.

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article 3 months old

Weekly Broker Wrap: Housing, Oz Equities, Consumer, Gold Stocks, FX And Asian Economies

-Deutsche Bank positive on housing
-Are equity raisings hindering growth?
-Morgans' consumer picks for a downturn
-AUD gold price support as US rates rise
-AUD, NZD rally fading?


By Eva Brocklehurst


Deutsche Bank confesses to being uncertain about what the word "peak" actually means when it comes to housing. Does it mean prices, or construction? Does it mean a peak in the growth rate or the level of construction?

The broker believes the distinctions are crucial to the picture. Recent falls in auction clearance rates may not mean house construction has peaked. It may pre-empt a slowdown in house price growth but, historically, there have been periods when house prices have been flat after a boom.

There is no reason why this time it should be different. The broker also contends there is scope for momentum to spread beyond Sydney, particularly to Queensland.

In terms of record housing starts, relative to the population these are below previous peaks. Deutsche Bank suspects there is a lot of catch-up to be done in terms of building. Construction needs to rise 20% to get back to trend.

The broker also believes renters, not mortgagees, are the ones struggling with affordability. The cycle is also well explained by domestic factors as foreign inflows are not that large in relative terms.

Apartment prices, the main target of foreigners, haven risen 10% less than detached houses. All up, Deutsche Bank finds it is not too difficult to construct a positive view on housing.

Portfolio Strategy

One reason cited for a lack of earnings growth in local stocks has been the large amount of equity issuance, with Goldman Sachs noting that few companies have embarked on a strategy of shrinking to grow.

There are around 400 global firms which have managed to shrink their share base by more than 10% since 2009 while only one Australian has achieved this, that being CSL ((CSL)). Goldman calculates that the net supply of Australian equity is running at twice its historical average. This is bucking a global trend.

Capital raising by the banks may have been a major contributor but the increased flow of small cap initial public offerings of shares has also been significant. Goldman notes the gap is widening between the amount of capital raised by small companies and their performance levels.

Since 2005, the market cap of the small ordinaries index has risen by 68%, despite the index having produced a negative return of 14% over that period, Goldman notes.

Consumer Discretionary

Morgans observes there has been speculation about Australia entering a recession. Regardless of whether this is the case, the broker takes a look at those stocks which would be best positioned to perform in a soft domestic economy with fragile consumer sentiment.

Burson Group ((BAP)) is considered to have defensive earnings growth and a lower Australian dollar should be offset by higher than expect cost synergies. The broker also likes Domino's Pizza ((DMP)), Super Retail ((SUL)) and RCG Corp ((RCG)) as these have strong core products and a dominant market position as well as reasonable valuation.

Wesfarmers ((WES)) and Lovisa ((LOV)) are also in the mix. The strength of the Wesfarmers balance sheet provides additional comfort it can weather a slowdown while Lovisa has a low average transaction value and the fast fashion nature of the product makes it more resilient.

Having a strong competitive advantage is also important and Morgans likes Beacon Lighting ((BLX)) in this regard.

AUD Gold

UBS suspects many investors have been avoiding gold because of risk aversion to commodities in general as well as expectations that higher US interest rates will weigh on the precious metal going forward.

Yet, as the broker notes, some gold names are up around 54% in the year to date, beating the Australian dollar gold price, which has risen 11% while the ASX-200 is down 3.0% comparatively. US interest rates remain the primary driver of the gold price but other factors are inflation, safe haven perceptions and central bank transactions.

Recently China lifted its official gold reserves and, when combined with strong consumer demand, UBS believes this transfer of physical gold from the west to the east could play a crucial part in how gold is priced in future.

The broker believes investor sentiment towards Australia's economy may mean the local dollar trades lower if the US Fed raises rates and this will offset any potential downgrade in the US dollar gold price.

UBS is drawn to Evolution Mining ((EVN)) for its free cash flow which is driven by output of 800,000 ozs per annum at an all-in sustainable cost (AISC) of $1,000/oz. Alacer Gold ((AQG)) also offers exposure to one of the lowest cost gold projects in the world and Regis Resources ((RRL)) has re-positioned to better compete in the mid-tier space with guidance of 200,000 ozs at an AISC of $1,020/oz.

Australian and New Zealand Currencies

Commonwealth Bank analysts suspect the recent rally in the Australian and New Zealand dollars will fade. The pair have risen since the beginning of October, mainly on the back of the weaker US dollar as market participants push back the start of the US Fed's rating tightening cycle.

The analysts believe surging commodity supply is a significant headwind to a recovery in the currencies as commodities comprise around 70% of the two countries' exports.

Mining commodity supply should stay strong because of a decade-long investment surge which has permanently expanded productivity capacity. It is not easy or cheap to close a mine.

The analysts have recently reduced 2016 forecast for global growth to 3.1% from 3.5% because of poor prospects for emerging markets. They believe there is a rising risk of crises in emerging markets. Both Brazil and Russia are already in recession.

In connection, the Australian dollar is often used as a proxy for non-Japan Asian currencies and these are expected to weaken because of soft demand in more advanced economies, which in turn reduces export demand from Asia. In this, New Zealand has less of a direct link but has a high export exposure to Asia via Australia.

The biggest risk to the analysts' view on the currency pair is a further delay to the start of rate hikes in the US.

Asian Economies

The CBA analysts expect most Asian economies will decelerate in the near term, as the demand for products made in the region remains sluggish. China's economy has been slowing for more than five years and there is further to go, the analysts maintain.

The housing market poses the largest threat to Hong Kong's stability as prices have risen more than 183% since 2009. A correction is pending, the analysts maintain. India's economy, meanwhile, is less exposed to global demand and should maintain momentum, driven by increased infrastructure investment and robust urban household consumption.

Indonesia's economic outlook is bleak given the soft commodity price environment but the government is pushing through some reforms to accelerate investment. Malaysia is also struggling while the Philippines has recently showed signs of weakening. The analysts observe South Korea will continue to moderate and growth in Taiwan has turned out at the slowest pace in three years.

Vietnam has been the exception recently, with faster economic growth and its export profile now more technology-intensive. One third of its exports now electronics.

Osprey Medical

Osprey Medical's ((OSP)) trial of the AVERT system did not achieve one of its primary end-points - a reduction in contrast-induced acute kidney injury in patients who had been administered dye with the AVERT system.

Still, based on interim data, the US Food & Drug Administration has approved the addition of claims for dye reduction, image quality and reflex reduction to the AVERT system approval. So, while the company cannot market the direct benefits of using AVERT, it will be able  to promote the product as the only FDA-approved system for minimising the amount of contrast given to patients.

As most guidelines recommend minimising dye, Canaccord Genuity believe  there will be robust adoption of the AVERT system by clinicians. The broker maintains a Buy rating and has reduced its target to $1.15 from $1.50 on the stock.


Chinese consumer demand for foreign health supplements is a bright spot as far as Blackmores ((BKL)) is concerned. Goldman Sachs believe the increased outbound travel to Australia and the popularity of the company's brand in Australia, as well as attractive margins, means strong earnings growth is on the cards for FY16.

The broker has upgraded its target to $150 on higher margins, given operating leverage from strong revenue growth. Goldman retains a Buy rating. The broker believes the stock's premium to the market is justified given its 3-year earnings growth rate  of 27% and high cash returns.

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article 3 months old

Has Australia’s Housing Cycle Peaked?

-House building ahead of population growth
-House prices at risk of downturn
-Subdued NSW home buyer sentiment
-Focus on US-exposed building stocks


By Eva Brocklehurst

Has Australia's housing cycle peaked?  This question has been stealing into broker commentary on the economy and housing related stocks recently. Macquarie and Morgan Stanley suspect the market has indeed peaked and Credit Suisse considers housing has now become riskier than equities.

Australia's population growth has slowed and this in turn will slow the transition to non-mining activity, Macquarie observes. Population, while still growing, is not advancing fast enough to warrant the surge in housing supply which will hit the market next year. Updated government projections reveal population growth has slowed to a 9-year low.

A smaller increase in population means less demand on construction based parts of the economy. Building approvals and housing commencements are around rates of 200,000 per annum, well ahead of estimates of underlying demand.

Macquarie observes, while supply undershot demand for several years and subsequently was calibrated into prices, the unleashing of pent-up demand will also have effects on price. Macquarie expects this surge in supply means real dwelling price reductions may be required in order to accommodate the reduction in the level of real income per dwelling as a result of lower economic activity.

The broker suspects some additional policy support from monetary authorities might be needed to curb the extent of downside in either prices or activity. The next reduction in official cash rates - Macquarie's base case is for another 25 basis points - is unlikely to be passed on in full, given additional prudential requirements for the banks.

In the absence of other stimulus to the economy, a well supplied housing sector is likely to delay the start to a normalising of rates too. Keeping servicing costs low for mortgages will be important in order to sustain growth in consumer spending and cushion a deterioration in balance sheets as asset prices decline.

Some incremental increase in the house price to income ratio could occur through to the end of this year, Macquarie believes, at which time a mild correction in house prices is expected to begin in 2016. The broker does not expect a return to growth in real household income until late 2017.

Through previous cycles policy-makers managed to avoid large falls in house prices, which have a subsequent destructive effect on business and household balance sheets, by easing their adjustments over a number of years.

Morgan Stanley agrees that slower net migration will take underlying demand for housing down by 30,000 per annum - to around 155,000 starts per annum. Although there may be some offset for those companies exposed to infrastructure spending this is expected to be longer dated.

Housing peaked in September and macro prudential policy had already started to tighten as, alongside limits on investor lending and higher mortgage risk weights, Morgan Stanley observed a tightening of lending standards since mid year.

The broker disputes the view that lower-for-longer rates will mean strong housing conditions persist. Instead, the slowdown in housing comes at an awkward time, when the drag on GDP from lower resource capex overwhelms the contribution from a lower Australian dollar and services exports. The broker believes recession risks are elevated while regulators attempt a soft landing in the housing market.

There is likely to be a regional perspective to the housing market too, Macquarie maintains, with declines in Sydney dwelling construction commencements not likely to be as significant, given strong population inflows. Perth, Brisbane and Melbourne apartments are where the regional correction is likely to be more concentrated in the broker's opinion.

Surveys pointing to very subdued home buyer sentiment in NSW have garnered Credit Suisse's attention. The correlation between sentiment and home sales is particularly strong in NSW. This state had previously benefited from both investor and foreign buyers. Macro prudential tightening, out-of-cycle rate hikes for investor mortgages and weakness in Chinese demand have all had a clear impact on sentiment. Sentiment is largely a function of affordability and affordability declines as house prices rise.

Still, this is not the whole story, Credit Suisse maintains. Even after accounting for local conditions, NSW tends to impact the sentiment in other states as Sydney leads the national market.  If high risk continues in housing, the analysts envisage rotation out of this asset class although it is difficult to diversify away from housing risk because it is highly correlated with equity risk.

Policy makers may welcome a cooling in the housing market and more rational pricing of risk, but the broker suspects they would not welcome a sharp decline in NSW housing demand.

This prospect worries the broker. Historical relationships point to home sales declining by more than 40% in the coming months. Should this eventuate, housing prices could flatten out or even fall as supply outpaces demand. Foreign buyers and investors have fueled demand in NSW as well as large net interstate migration. Now many of these supportive factors are weighing on the market.

Against the more challenged domestic environment, Morgan Stanley expects US housing will continue to improve and New Zealand should also be positive on a medium-term basis. This should support stocks such as James Hardie ((JHX)) and Fletcher Building ((FBU)), which were recently upgraded to Overweight. The US improvement is also likely to offset the Australian residential exposure for Boral ((BLD)).

The broker downgraded both CSR ((CSR)) and DuluxGroup ((DLX)) to Underweight at the same time, on the back of a downgrade to aluminum price estimate for the former and a difficult market in Australia for the latter. Morgan Stanley retains an Underweight rating for Adelaide Brighton ((ABC)) as well. The potential for strategies surrounding the Port Kembla steelworks provides support for BlueScope ((BSL)), despite the residential exposure and commodity price weakness.

Macquarie today made a number of changes and amendments to individual stock ratings and forecasts that do not always fall in line with Morgan Stanley's decisions. See the Australian Broker Call Report on the FNArena website today.

Morgan Stanley expects further falls in auction clearance rates and house price momentum, with a negative impact on construction occurring over 2016. Still, a significant backlog in activity should support volumes over the next 12 months especially in multi-dwelling activity.

While renovations tend to lag the upswing in new house construction slightly and prove more resilient, this time Morgan Stanley notes persistently weak activity in this segment. This could reflect a broader de-leveraging trend among householders but also the trend towards re-developing established property into higher-density apartment blocks.

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