Tag Archives: Consumer Discretionary

article 3 months old

GUD Holdings Better Off Without Dexion

GUD Holdings is hampered by its Dexion division, brokers maintain, and would be better off divesting the business.

-Trade sale of Dexion considered GUD's best option
-Automotive outlook robust and increasingly important
-Although FX tailwinds easing and margins likely peaking


By Eva Brocklehurst

G.U.D. Holdings ((GUD)) was hampered by the performance of the Dexion storage system in FY16, while the automotive division starred and Davey pumps appears to have turned around. The company is expecting a return to growth in Oates cleaning products after the division deteriorated in the second half.

FY16 earnings fell short of broker expectations and guidance, with Dexion the main culprit. Despite the profitable June quarter at Dexion, a lack of confidence in the top line has led to a $75.7m pre-tax impairment and the initiation of a strategic review. GUD has signalled an interest in bolt-on acquisitions for automotive and Davey in the next year. The portfolio continues to shift towards automotive, which was 78% of FY16 earnings.

The automotive segment is the key reason Macquarie would own GUD. Ryco provided 10% earnings growth and Brown & Watson International (BWI) performed well in terms of margins in its first year of GUD's ownership, delivering earnings well ahead of initial expectations.

The automotive division underpins organic growth forecasts, although it is clear to the broker management is exploring acquisition opportunities. Macquarie also envisages considerable opportunity for joint promotions and cross-selling between Ryco and BWI. Management is targeting 30% earnings margins at BWI and expects growth across the automotive division to be above average over the next few years.

The ability to offload Dexion is key to the future of the company, brokers maintain. The division incurred a $3.8m earnings loss for FY16, affected by weaker commercial demand. Macquarie understands closure of the business is not an option and a sale is the preferred route in FY17. A divestment anywhere near book value ($44m) would be a great outcome, in the broker's opinion, although interest is most likely limited to other industry participants which could realise substantial synergy benefits.

Meanwhile, GUD has re-rated on the back of the Sunbeam divestment and appears fairly valued to brokers with further upside if management is successful in divesting Dexion. Ord Minnett considers the potential for further portfolio rationalisation is reduced in the near term but the company has a robust automotive division to turn to with strong cash conversion.

Dexion's high fixed cost base is exacerbating the weak order book and, in the case of Oates, price rises are required to offset FX headwinds, but the broker notes this is difficult in the current grocery and hardware setting.

While the outlook for Dexion is challenging and broader demand is soft, UBS points out this segment is now far less important to the company compared with back in FY12 when it accounted for 10% of earnings. The strategic review suggests a trade sale is an option and the recent exit from Sunbeam illustrates a willingness and ability to divest under-performing divisions.

In the meantime, the automotive division is defensive and comprises imported branded consumer businesses with high market share, although the FX tailwinds which have been a feature of recent years are easing and the broker suspects margins have peaked. UBS believes there is an opportunity for GUD to simplify, divest segments and become more of a pure play in the automotive aftermarket.

Credit Suisse believes the considerable earnings uncertainty within Dexion, in particular, counters any positive potential from mergers and acquisitions. That said, the broker also maintains that the divestment of Dexion would be a positive catalyst and remove a volatile earner that overshadows the stock, allowing capital to be redeployed more constructively.

FNArena's database has one Buy rating (Citi) and four Hold. The consensus target is $9.47, suggesting 5.3% downside to the last share price. Targets range from $8.80 (Citi) to $9.90 (Macquarie, Ord Minnett). The dividend yield on FY17 and FY18 forecasts is 4.7% and 5.2% respectively.

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article 3 months old

Woolworths Turnaround Requires Patience

-Slight progress at supermarkets
-Store closures, fewer new stores
-Concern over credit metrics
-Upside potential when turnaround realised

By Eva Brocklehurst

Woolworths ((WOW)) has bitten down harder on the restructuring bullet, detailing more impairment charges, operational changes and store closures. Brokers generally approve of the strategy to close underperforming stores and open fewer new ones. Nevertheless, the turnaround is expected to take some time to reap benefits.

The company will incur restructuring costs of $959m in FY16, including support functions and supply chain costs. Write-downs in general merchandising total $460m and the division is expected to incur a loss in FY16, with Big W to report a loss of $12-17m and EziBuy $13-18m. Excluding one-offs, FY16 earnings are expected to be $2.55-2.57bn.

Deutsche Bank notes some confusion in the market as to whether the Masters loss is included in the FY16 earnings guidance. The broker previously included home improvement in its estimates but, to avoid confusion, now takes it below the line. A further update on the home improvement segment is expected at the results.

There was also no trading update on June quarter sales but management did suggest there are signs of progress in Australian supermarkets. Yet deflation has intensified and Deutsche Bank notes de-leverage is compounding at least another nine months of price investment. Staff morale and supply chain issues remain significant.

The update is another step forward to reinvigorate the group and Goldman Sachs is encouraged by the new CEO's preparedness to make difficult decisions. The broker suggests comments around incremental improvement in June and July signals price investment could be gaining traction with customers. Still, the industry is highly competitive and any sustainable recovery in food & liquor earnings is unlikely to be evident until late FY17.

Moreover, in recent years Woolworths has been growing its stores faster than its sales, with the result being a declining rate of sale per square metre. The broker notes store closures are aimed at turning this around but, with just 17 stores being closed out of 976, suspects the initial impact will be modest. Goldman, not one of the eight stockbrokers monitored daily on FNArena's database, retains a Neutral rating and $21.50 target.

Ord Minnett concurs, given unrelenting competition in supermarkets, that a turnaround in sales growth in food & liquor, sales per square metre and earnings margin is uncertain and long-dated. In addition the broker remains concerned around the balance sheet and an elevated valuation. Balance sheet risks could arise too, assuming the company takes steps to maintain its BBB investment grade credit rating. Hence, Ord Minnett retains a Lighten rating.

Management's comment that a capital raising is not in its plan, suggests to Morgan Stanley Woolworths will fully underwrite its dividend, given heavy cash outflows in coming years. The broker also points out that this is not the first time Woolworths has hinted supermarket trading has improved and calculates volume growth based on food & liquor sales has actually been positive since the fourth quarter of FY15.

Morgan Stanley lifts FY17 margin estimates to 4.25% from 4.1%, given Woolworths intends to close the 17 stores. Still, even after a modest upgrade the broker still expects a $320m profit reduction in Australian food & liquor in FY17. The broker warns margins rarely rebound after a re-basing and Woolworths now trades at a 26% premium to its global supermarket peers, despite operating with higher margins and more financial leverage.

A $110-180m favourable impact is expected on earnings in FY17 as a result of provisioning for onerous leases, lower amortisation expenses and lower labour costs, yet Credit Suisse does not perceive a level of performance improvement that would justify a valuation upgrade. The broker likes the strategy, while actions taken in supermarkets appear to be stabilising volumes and refurbishments should improve sales growth through FY18.

Still, the broker agrees there is unlikely to be the opportunity to expand earnings margins or market share. The business has the cash flow to implement its restructuring and maintain a 65% dividend pay-out ratio and Credit Suisse downgrades to Neutral from Outperform given the sharp rally in the share price.

Macquarie believes the stock is factoring in a large degree of optimism in its share price. Tentative improvements in customer perceptions at the supermarkets remain some distance from positive comparable sales growth, given the highly deflationary environment, the broker attests. Moreover, volume growth and cost reductions are unlikely to be enough to offset the annualisation of second half poor margin performance in supermarkets.

The restructuring is necessary and Macquarie welcomes the shift to store refurbishment from expansion, as it provides some structural growth drivers beyond the medium term. The broker also agrees there is not much room left in the credit metrics before Woolworths is downgraded.

Shaw & Partners, not one of the eight monitored daily on the database, is also sceptical about the quantum of positive signs, noting this is the slowest growth period for Woolworths in over two decades. Yet, given a valuation of $24, the broker remains comfortable with a Hold rating. Shaw also observes the update incontrovertibly shows Woolworths has been over-earning on margins and top line versus global peers in the past few years, given the returns generated by the supermarkets.

UBS expects the issues the company faces can be fixed over time but the turnaround is likely to take longer and cost more than many expect. The broker reiterates a Sell rating and expects deteriorating trends in grocery will continue. If, and when, the turnaround emerges the broker envisages potential for material upside.

FNArena's database shows three Hold ratings and five Sell. The consensus target is $20.45, suggesting 13.1% downside to the last share price. Targets range from $18.00 (Ord Minnett) to $24.50 (Credit Suisse).

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article 3 months old

Strong Growth Ahead For Shaver Shop

-Substantial market share
-Buying back franchises
-Dividend forecast for FY17


By Eva Brocklehurst

Shaver Shop ((SSG)), a specialist retailer in hair removal and personal care, has delivered strong sales growth over recent years, brokers observe, despite varied economic conditions that have prevailed.

Shaw & Partners considers the stock an attractive retail story, with strong underlying fundamentals. On most metrics relative to the 60 ASX-listed retailers the company is in the top quartile for like-for-like sales growth, stability of margins, sales per square metre and new store roll-out.

Shaver Shop listed on ASX this month, with both Shaw & Partners and Ord Minnett involved in bringing the stock to market. Shaw & Partners initiates coverage with a Buy rating and target of $1.45. Ord Minnett applies a Buy rating and $1.35 target, which it notes implies a 26.1% total return in the next 12 months.

The company is forecasting pro forma FY16 and FY17 corporate store sales of $106.2m and $127.1m respectively. Earnings are forecast at $12.5m and $14.7m respectively. Like-for-like sales growth of 2.5% is estimated for FY17, despite having achieved an average of 8.6% from FY13-15. Apart from the cycling of a strong comparable period, Ord Minnett envisages no reason why sales strength should reverse.

Key drivers of sales estimates are the impact of buying back franchised stores and the opening of new stores undertaken in FY15/16. Nine franchises are expected to be bought back in FY16/17 with 20 new stores being opened. As of June 30 there are 100 Shaver Shop stores across Australasia, of which 81 are company operated.

The company estimates there is up to $5.0m in additional earnings which can be acquired from buying back the remaining franchises. Shaver Shop aims to grow its network to around 145 stores. Online sales have consistently increased as a percentage of total sales, allocated to the store nearest the customer's delivery address.

Ord Minnett likes the combination of sales growth and buying back of franchises and believes earnings momentum can be maintained. A prudent capital structure enables the company to roll out stores at the same time as buying back franchises, the broker notes, without stretching the balance sheet.

The broker also highlights the fact that the company has a 28% share in the personal care appliances market, with barriers to competition provided by Shaver Shop's significant position and exclusive product range.

Risks? The company relies on suppliers to continue to drive innovation in products in order to maintain sales growth. A material reduction in the frequency or appeal of new products, or a change in the company's ability to secure a significant portion on exclusive terms, may impact earnings.

Shaver Shop doesn't just sell shavers. The company’s products include hair care, oral care and massage categories as well as air purifiers and pet grooming products. The company has long-standing strategic relationships with Procter & Gamble, which has brands such as Gillette, Braun and Oral-B, Conair, Panasonic, Philips and Remington.

The majority of the products the company retails are manufactured internationally, with Shaver Shop purchasing inventory from Australian distributors in Australian dollars. The company does not engage in foreign exchange hedging.

The company intends to target a dividend pay-out ratio of around 50% of profit in each year and pay interim dividends in respect of half year periods. Future dividends are to be franked to the fullest extent possible. Directors forecast a dividend of 4c for FY17, split 50:50 between an interim and final dividend.

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article 3 months old

Eagle Boys Feel Domino’s Effect

- Domino's supreme pizza chain
- Eagle Boys hold the anchovies
- Further market share opportunity


By Greg Peel

Deutsche Bank estimates that of the Australian “chain” pizza market, which presumably excludes your local Italian pizzeria on the corner that does the fabulous Calabrese, Domino’s Pizza ((DMP)) controls 50%. Thereafter, veteran Pizza Hut and Crust/Pizza Capers each split the balance but for a less than 10% slice (Morgan Stanley says around 6%) which Eagle Boys controls.

Press reports suggest the Eagle Boys have put their head office into voluntary administration. This will not immediately impact on the 127 franchises which will continue to operate normally until a possible sale is negotiated and/or restructuring measures are considered.

By contrast, Domino’s was operating 681 stores in Australia/NZ at the end of last year and Pizza Hut currently has around 270. The difference between 681 stores and 127 suggests Domino’s boasts the advantages of significantly larger scale when it comes to procurement, leveraging marketing spend and head office costs, Deutsche Bank notes. This is evidenced by the fact Domino’s can offer a $5 pizza.

The dominant player has also invested heavily in technology that addresses the two major issues facing the quick service restaurant (QSR) market – cooking time and delivery time. This has put more pressure on the likes of Pizza Hut and Crust but would have had a greater impact on the smaller Eagle Boys, Deutsche assumes.  

There has been speculation in the past, following franchisee dissatisfaction in the Eagle Boys camp, that Domino’s would be interested in taking over. No, was the answer, given Domino’s is not keen trying to retrain franchisees into a whole different culture. Nor would it be likely, Deutsche believes, Eagle Boys franchisees would be eager to invest the capital required to rebrand to a Domino’s, and either way, it has come to the point the ACCC might have an issue with growing Domino domination.

That said, Morgan Stanley cites a monitoring service in calculating Domino’s share is not as much as 50%. Prior to the Eagle Boys news, the broker had forecast an increased market share in Australian pizza to 37.4% in FY16 and 42.8% in FY17. Perhaps the difference is New Zealand – it’s unclear. Whatever the case, if Eagle Boys ends up closing then this would accelerate Domino’s potential market share gains, Morgan Stanley assumes. The leader could pick up lost business and accelerate store openings in existing Eagle Boy locations.

Domino’s franchisees generate 40% higher sales per stores than Eagle Boys’, the broker points out, and thus are likely far more profitable. That said, Morgan Stanley also notes, Pizza Hut appears to have managed to slow its same store sales growth decline in the June quarter, according to US owner Yum! Brands’ quarterly result. So not everything is heading Domino’s way alone.

Deutsche Bank believes that on balance, this development is positive for Domino’s. There is a risk, nonetheless, that Eagle Boys comes safely out of administration as a stronger business. Morgan Stanley sees a market share opportunity and already had Domino’s as its key consumer pick.

At $80, Morgan Stanley’s price target for Domino’s is way ahead of the pack, and justifies an Overweight rating. Deutsche’s target of $57 is well short of the current trading price, hence a Hold rating.

Four other FNArena database brokers cover the stock, for one Buy and three Hold or equivalent ratings, but none have updated their view since the first half result season in February. We may thus take targets in the range of $53.32 to $63.20 with a grain of salt. Currently the consensus database target is $61.69, suggesting 16% downside.

Domino’s will report its second half earnings on August 16.

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article 3 months old

Treasure Chest: Attractive Entry Point For Blackmores

- Regulation selling overdone
- Bricks & mortar opportunity substantial
- Solid earnings growth ahead

By Greg Peel

In February 2015 the shares of vitamin and dietary supplement supplier Blackmores ((BKL)) were trading at $40. In February 2015 they hit $220. Then the wheels fell off. Currently they are trading around $140.

Blackmores’ 2015 surge was all about China discovering vitamins and supplements in plastic bottles for seemingly the first time. It was another step in the Westernisation and rising middle class in a country that for eons has put faith in herbs and powdered animal parts. Infant formula was also discovered, hence the equivalent rise in the shares of A&NZ powdered dairy product suppliers.

The wheels fell off in early 2016 for two reasons. The primary reason was a clamp-down on import regulations from the Chinese government. This was reason enough for investors to fear an end to the rivers of gold. But because Blackmores shares had run so far, so fast as the herd climbed over itself, clearly any sliver of bad news was set to spark a big share price overreaction.

China’s import rules are murky at best. Last April the government introduced rules restricting import volumes via the cross-border e-commerce channel. Blackmores sells its products to China mostly on-line. Clearly there was reason for investors to be concerned.

But most of those sales are not via the e-commerce channel. Credit Suisse notes 70% of sales are via the “daigou” channel in which Australian selling agents use Chinese personal post. This channel has been less affected by new regulations. Peer A2 Milk ((A2M)), also operating in the daigou channel, suggested last month the impact from regulatory changes has not been as bad as feared.

Credit Suisse thus believes the impact on Blackmores’ business is not a great as the share price fall implies. But more importantly, the broker sees another Chinese regulation development that should prove very positive for Blackmores, via the good old bricks & mortar channel.

The Chinese Food & Drug Administration is supplementing its existing lengthy and costly registration process with a faster and simpler procedure for 22 common vitamins and minerals. This should allow Blackmores to expand its product range in Chinese stores materially, Credit Suisse suggests, perhaps threefold.

The analysts took a trip to China to see for themselves. There they found wide brand awareness and perceptions of quality. Blackmores is adding resources to exploit the Chinese market faster than its peers and has established a local subsidiary and distribution relationships.

In short, Credit Suisse believes Blackmores’ China sales could double by FY20, driving a compound annual growth rate in earnings of 16% over the period. By then, China sales could account for half of group sales.

The broker has initiated coverage of the stock with an Outperform rating and $175 target.

This brings to three the number of major FNArena database brokers covering the stock. Morgans last updated in May, following the regulation-driven sell-off, at which time the broker highlighted a strong March quarter for the company in China nonetheless. Morgans lifted its price target marginally to $168.10 but retained a Hold rating, believing the stock to be fully priced.

Ord Minnett last updated in February following the company’s half-year result release. The broker at that time was espousing a potential “seismic shift” in the growth outlook for companies such as Blackmores, exposed to the growing Chinese middle class. On that basis, despite the 2015 share price surge, Ords retained a Buy rating.

Then Beijing changed the regulations. On that basis we’ll assume Ords’ $225 target will be readdressed when Blackmores posts its full-year result next month.

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article 3 months old

Retailers Facing Tough Times

-Supermarkets weakest in 10 years
-Online food sales accelerate
-Chains winning in household goods

By Eva Brocklehurst

Retailers are facing a tough outlook, with brokers suggesting the sector is mired in post-election uncertainty amid continued weakness in the supermarkets as competition remains intense.

Moreover, Bell Potter points out discretionary sales were soft in May, month on month, particularly in the light of the reduction to the cash rate the Reserve Bank of Australia instigated on May 3. Australian Bureau of Statistics retail sales data showed growth slowed in May to 2.4% annual compared with the 4.9% pace in April.

Food sales weakened for the second month in a row and Morgan Stanley notes supermarket sales growth is at its weakest in over ten years, growing at just 0.7% versus 3% in January to April. The broker suggests ongoing investment in price, as a result of competitive pressures, and fresh food deflation are the drivers of the weakness. in light of the data the broker envisages a higher level of earnings risk for Coles ((WES)) and Woolworths ((WOW)).

Following Aldi's arrival in South and Western Australia, market growth has slowed further, Morgan Stanley observes, with the step-up in price investment the likely driver. NSW and Victoria report the strongest growth in the supermarket category.

Housing-linked retail growth has also slowed. ABS data shows sales were up 2.9% in May versus 9.5% in April (annual). The warm start to winter may have acted as a headwind in the electrical category but would have been supportive for the hardware category, Morgan Stanley attests. Brokers also suspect consumers became more nervous as the federal election loomed.

Countering this, online takeaway foods sales growth has accelerated in recent months, which, in Morgan Stanley's view, implies a strengthening in Domino's Pizza ((DMP)) sales, given this business is a considerable portion of the category at around 40%.

Ord Minnett expects earnings re-basing to continue for Woolworths, which will, in turn, weigh on the entire food industry. Across the discretionary sector the broker retains a preference for Super Retail ((SUL)), a specific turnaround story, or those with a skew to home categories, such as Harvey Norman ((HVN)).

The broker acknowledges the comparable prior period in the home sector was a tough measure to cycle. The medium-term outlook for the discretionary retailers is still robust, the broker contends. Recent employment growth is offsetting lower wage growth and housing wealth factors support consumption in selected categories.

UBS also observes the chains are winning in the household goods category and the smaller players are losing market share. In the sub categories, furniture was weak and electrical slowed, but hardware was solid.

The broker still expects mid single digit growth in household goods to continue, adding over $200m to industry sales in 2016, and Harvey Norman should have further upside. UBS continues to favour the latter along with JB Hi-Fi ((JBH)), Myer ((MYR)) and Adairs ((ADH)).

The risk in supermarkets is weighted to the downside, UBS maintains and its Sell ratings on Woolworths and Metcash ((MTS)) are unchanged. The broker notes suppliers now expect shelf-price deflation over the next 12 months.

Growth for the food & liquor segment overall, beyond just supermarkets, may have been better, driven by continued acceleration in liquor. UBS forecasts 3.4% growth in the F&L segment over 2016 but agrees the latest data suggests the downside risk prevails. The broker flags the fact that the independent supermarkets lost share in May at a slower rate versus the 12-month average, which is a a positive note for Metcash.

Soft growth in the cafe/restaurant segment does not bode well for Coca-Cola Amatil ((CCL)), UBS asserts, but the May data was positive for Super Retail.

Bell Potter expects muted growth overall in June/July, with the numbers signalling softness across the categories, with recreational goods the exception that recorded positive month-on-month growth. Department store sales were flat.

The positives include low interest rates, benefits from a lower Australian dollar and the housing wealth effect. These will be offset by the uncertainty over the election result, slower housing turnover and market volatility stemming from the British decision to exit the EU, Bell Potter believes.

The broker's stock picks are unchanged and include RCG Corp ((RCG)), with its acquisitions and store roll-out opportunities; Premier Investments ((PMV)), as the pull-back in the share price provides an attractive entry point to the Smiggle growth outlook; and Super Retail, where strong earnings growth is expected to be driven by an improvement in leisure categories.

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article 3 months old

Treasure Chest: Treasury Wine Bubbling Over

By Greg Peel

Treasury Wine Estates ((TWE)) had previously guided to FY16 earnings guidance of $290m not including the Diageo acquisition, and has now updated to $330-340m inclusive of Diageo earnings. The company notes this forecast is in line with market estimates.

Treasury Wine will also divest of its non-core US portfolio at book value. This will have little impact on earnings, analysts suggest, given supply chain cost savings.

The question is as to whether both the company and the market are getting a little carried away. Morgan Stanley suggests both the guidance upgrade and divestment were already priced in, and given the strong share price run the broker sticks to an Equal-weight rating.

Ord Minnett’s earnings forecast of $326.6m falls short of new guidance but the broker is prepared to believe Diageo is continuing to perform strongly in Asia and has benefitted in the US from the lower Aussie. Ords nevertheless retains a Lighten rating, which sits below Hold. If you’ve been holding the stock now is time to cream off some profit, the rating implies.

While Credit Suisse’s forecast of $335m is in line with new guidance, the share price run has taken the stock’s FY17 PE to 30x – higher than Treasury’s luxury goods peers and higher than even that of Blackmores ((BKL)), another company benefitting from growth in Chinese demand.

Having crunched the numbers, Credit Suisse suggests that despite this fresh guidance, the market is expecting an upgrade. Working backwards implies an expectation of at least 45% organic growth in Asia augmented by organic growth in other regions. The broker is forecasting 20%.

Moreover, while the management has suggested there will be no negative impact from Brexit, Credit Suisse assumes there will be some drag from the lower pound. And the forex gain Treasury enjoyed in FY16 from the lower Aussie is unlikely to be repeated in FY17.

Credit Suisse is maintaining an Underperform rating on Treasury Wine.

Other FNArena database brokers are yet to update on new guidance. At present, the stock attracts no Buy or equivalent ratings, rather four Holds and three Sells (including Lighten from Ords). The consensus price target is $9.03, suggesting 5% downside.

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article 3 months old

Automotive Holdings Better Off Without Logistics

-No meaningful synergies
-Slower growth in logistics
-Value unlocked if divested


By Eva Brocklehurst

Automotive Holdings ((AHG)) has underperformed over 2016 against both the Small Ordinaries index and its major listed peer, AP Eagers ((APE)). Several brokers blame the poor performance on the company's refrigerated logistics business, which has dragged down a robust automotive retailing division.

Refrigerated logistics has been a significant source of both broker and investor disappointment over recent years, failing to achieve management's targets. To brokers there are no meaningful synergies to be derived between the two divisions. Conditions over the second half in logistics have deteriorated and the company remains part way through an operational review.

Ord Minnett contends that capital intensity, poor returns and earnings volatility in the logistics business has affected investor sentiment. On a like-for-like basis, and valuing the automotive retailing at a conservative 20% discount to AP Eagers, the broker calculates that the market is attributing zero value to Automotive Holdings' other businesses.

Ord Minnett believes pressure is mounting on the board to do something and undertake an accretive transaction. An in specie distribution to divest the logistics business is considered the best way to go. The broker believes an outright sale would bring capital into the company but there is a risk that capital losses could be trapped within the group.

On the other hand, an in specie distribution would lead to much greater shareholder value creation. Both entities are likely to attract a level of corporate appeal, Ord Minnett adds. The broker's analysis of de-mergers in Australia over the last 15 years indicates that de-merged entities, on average, outperform the broader market by around 10 percentage points per annum over the subsequent two years.

Macquarie calculates Automotive Holdings generated 70% of first half earnings from the automotive dealership. There has been regulatory concerns over future commission payments but, offsetting this, the broker contends there is a large opportunity in the second hand vehicle market. The stock looks oversold too, on both regulatory fears and the logistics outlook.

Macquarie substitutes AP Eagers' FY17 automotive multiple in its AHG valuation and calculates a share price target of $6.89 suggesting, to achieve this multiple, the logistics business would need to improve considerably.

The broker has lowered forecasts for logistics in recognition of a slowing economy and lower growth from the major food retailers while estimates for the automotive division are unchanged. Moreover, the underlying assumption of no organic growth in FY17 makes allowance for any revenue and margin pressure from the outcome of the Australian Securities and Investments Commission review.

At the company's first half results it disclosed that ASIC is reviewing finance and insurance revenues in the automotive dealer industry, looking at commissions on consumer finance to ensure a fair outcome for consumers.

FY16 is likely to deliver a disappointing result, magnified by the opportunity cost of a misallocation of capital, in Deutsche Bank's view. The broker agrees the market's disappointment is warranted and predicts logistics earnings in FY16 of $39m, approximately 40% below the projected earnings base from two years ago.

The company has invested $311m in capital into this business since FY10. Had the capital been invested into automotive, Deutsche Bank maintains earnings in FY16 could have been 29% higher than forecasts currently suggest. This broker also expects significant value can be unlocked by the divestment of logistics but considers the probability highly uncertain, although it would be a major catalyst for the stock.

If the company chooses to divest the logistics business for around $150-250m - it has indicated it is open to offers - and redeploy the capital to automotive, the broker expects it would be accretive by 9-21%.

The operational review and any benefits forthcoming are likely to take longer to realise than first anticipated, Deutsche Bank maintains. Moreover, it will overshadow a very good automotive result. The broker notes Australian new vehicle sales have been strong over the first five months of 2016, with year-to-date sales in May up 3.8%. While the risk/reward proposition remains favourable, the broker retains a Buy rating.

FNArena's database has three Buy ratings and three Hold. The consensus target is $4.40, suggesting 14.3% upside to the last share price. The dividend yield on FY16 and FY17 forecasts is 5.9% and 6.3% respectively.

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article 3 months old

Weekly Broker Wrap: Insurance, ESG, Banks And Consumer Stocks

-NZ market shift from IAG
-NSW CTP reform in train
-Opportunities after Brexit
-GBP fall benefit to Praemium
-Pureprofile undervalued?


By Eva Brocklehurst


Macquarie has reviewed the New Zealand general insurance market, noting market pressures continue and market share is shifting away from Insurance Australia Group ((IAG)) towards new entrants such as Youi and Ando. New Zealand accounts for around 19.8% of IAG's FY15 gross written premium and around 13.6% for Suncorp ((SUN)).

New Zealand appears to be following the same trajectory for premium rates and margins as Australia, the broker observes. Motor claims cost inflation was singled out as an issue, a function of foreign exchange and low oil prices meaning people are travelling more domestically. On this issue, the broker notes Suncorp has set up a SMART repair shop in Auckland, with intentions of rolling out more in the next few years.

Personal lines premium rate forecasts suggest 5% growth in motor and no growth for home insurance. Commercial lines premium rates are forecast to be down across the board. Macquarie reduces IAG earnings estimates by 1.5% for FY16 and by 1.6% for FY17. Suncorp earnings are reduced by 2.8% for FY16 and by 0.9% for FY17. Suncorp remains the broker's preferred general insurance stock.

The NSW government has released the CTP (green slip) reform position, with a goal to introduce legislation to parliament later in 2016 and the new scheme to come into effect in 2017. The government proposes a hybrid scheme with defined benefits to all those injured in motor accidents regardless of fault with modified common law damages, fault based, for the more seriously injured.

Should the proposals be introduced the increased frequency of claims experienced over recent times should moderate, Macquarie maintains. Until this occurs the broker expects ongoing claims issues to dog the sector.

The broker also observes QBE Insurance ((QBE) and Allianz are taking most of the Zurich share after that company pulled out of the NSW CTP segment on March 1, 2016. While QBE is winning share and there has been pressure on profitability, the broker recognises NSW CTP accounts for only 2.4% of group gross written premium.

Recent data on NSW market share shows IAG has 33.2%, up from 31.1% in December 2015, Suncorp has 23.9%, up from 21.6% and QBE has 23.2%, up from 22.7%.


Environmental, Social and Governance (ESG) research, which explores sustainability and accountability among ASX stocks and integrates this into the investment process, seems to support outperformance in certain cases, Credit Suisse maintains.

The broker ponders why, given during conferences the question of how and when this research is prioritised is often asked. The conclusion is that ESG probably supports outperformance in a number of ways. It may indicate future value creation, protect existing value, indicate constructive behaviours or predict a future operating environment.

The ESG factors are not widely considered because the information is costly to find and hard to interpret. Yet, Credit Suisse believes taking ESG into account forces its analysts to extend the scope and timeline of their research, which should improve its quality.


Further to the ESG analysis Credit Suisse identifies the top risks for the commercial banking sector. Immediate concerns relate to social and regulatory risks, particularly the potential for a Royal Commission into banking, and possible class action damages which could follow from successful Australian Securities and Investments Commission (ASIC) litigation alleging rigging of BBSW markets.

This creates a key event catalyst regardless of which party wins the federal election. A more infrequent social risk is the vulnerability of systemically important banks, with their high equity gearing creating solvency issues during periods of financial stress and rendering the prospect of a taxpayer funded bail-out. The broker believes this is essentially an unsolvable risk but also one that is rarely experienced in practice.

What makes the broker's bank analysts happy? Despite cyber security risks, they cite new banking markets such as international wholesale banking/trade finance and new labour sourcing opportunities. Banks are net beneficiaries of technology which has been driving multi decade productivity improvements.

High Conviction Stocks

Morgans believes the surprise outcome of the UK referendum regarding exit from the EU has thrown up opportunities for investors. The broker includes BHP Billiton ((BHP)) and Smartgroup ((SIQ)) in its list this month, removing NextDC ((NXT)), Vitaco Holdings ((VIT)) and CYBG ((CYB)).

BHP is added because of its robust cash flow and with a key driver being the oil price, an important feature given oil demand is largely unresponsive to Brexit. Smartgroup has been significantly de-risked in terms of regulatory change and has a strong track record of organic growth, which is assisted by recent contract wins.

The broker expects any short-term volatility will be alleviated by central bank support but advocates investors be selective with their exposure as risks abound. Morgans considers the Brexit a direct risk to CYBG, with the uncertainty signalling potential declines in UK GDP and credit growth because of higher unemployment and a softening housing market.

Vitaco is removed from the list as the broker envisages few near-term catalysts for the stock to re-rate. Meanwhile, NextDC has performed well over the last few months but, as its inclusion in ASX200 did not occur in the quarterly index re-balancing, that catalyst has passed and it is removed from the list.


Morgan Stanley warns that stock specifics, rather than the Australian consumer cycle, will drive shares over coming months. The broker favours those in earnings upgrade cycles such as Domino's Pizza ((DMP)) and JB Hi-Fi ((JBH)) and oversold stocks such as Metcash ((MTS)) and Super Retail ((SUL)).

Woolworths ((WOW)) remains the broker's highest conviction Underweight stock, as ongoing pressure on supermarket earnings are expected. The broker is Equal-weight on Wesfarmers ((WES)), given the strong outlook for Bunnings even though growth at Coles appears to be slowing.

In discretionary retail Morgan Stanley most prefers JB Hi-Fi and least prefers Harvey Norman ((HVN)). JB Hi-Fi appears set to profit from being the last one standing in software while Harvey Norman is most susceptible to a slowing Australian housing outlook.


Praemium ((PPS)) has announced a major contract with JBWere for portfolio administration and software, V-Wrap. The contract is estimated to be ultimately worth around $1m per annum as JBWere progressively implements V-Wrap to all wealth management client portfolios.

Bell Potter believes this new blue chip client validates the recent development of capabilities on the platform. The broker currently forecasts the UK business to be loss making for the next three years, yet the resultant weakening in the British pound from the Brexit vote, combined with a weaker rate against the Australian dollar, means smaller operating losses as the business heads towards profitability.

Bell Potter upgrades estimates based on this new contract and a stronger Australian dollar cross rate, offset to some degree by weaker net flows and marking to market estimates. Buy rating is retained. Target lifts to 62c from 56c.


Shaw and Partners considers marketing technology company Pureprofile ((PPL)) is undervalued for a stock that is already profitable and delivering on its strategies. While the broader market is uncertain, the broker notes the company benefits when research efforts are increased and companies look for deeper insights into marketing their brands.

The stock is trading on a 12-month forward price/earnings ratio of 11 and the broker believes the risks associated with investing in the stock are less than for its small cap peers. Shaw and Partners retains a Buy rating and 79c target.

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article 3 months old

Wesfarmers Dividend Likely Under Pressure

-Competition intense for Coles
-Target, UK strategy considered sound
-Yet risk of credit downgrade


By Eva Brocklehurst

Brokers increasingly suspect Wesfarmers ((WES)) may have to reduce its dividend, as the near term holds some negatives for several divisions and there is competitive pressure on its major earner, Coles. The company's strategy briefing contained few changes, with no formal guidance as usual, but brokers continue to reduce sales growth forecasts for Coles amid increasing evidence of price competition.

Morgan Stanley observes this to be the case, with the company indicating fresh food deflation has accelerated in the June quarter, yet volumes are unchanged. Management asserts strong seasonal growing conditions are behind the deflation and does not expect this to continue beyond the near term. Yet, the broker maintains, even outside of fresh food, prices are falling month to month. Morgan Stanley also notes Coles continues to increase the proportion of products sourced directly and this is driving improvements in its buying terms.

While not quantifying the magnitude, management expects there are more cost savings to be had at Coles, and savings are expected to be reinvested in price and promotional activity. Management remains confident in a rational supermarket playing field, which somewhat surprises UBS, as this market is growing at half the pace of 10 years ago and industry profits are falling for the first time in over 10 years. The broker believes the rate of earnings growth at Coles is at risk into FY17 if competition is increasing.

Ord Minnett suggests concerns around lower earnings growth at Coles are now better appreciated by management, and the supermarket, Bunnings, Kmart and Officeworks, are attractive features of the stock. Hence, while valuation support is modest, the dividend yield and underlying earnings growth remain appealing in a market where attractive investment options are few.

Moreover, Credit Suisse does not believe there is a major issue for the balance sheet, unless there is a sudden burst in capital expenditure, which is unlikely. Still, until the Target and Homebase (UK) businesses are transformed, the company is considered at risk of a credit downgrade, although the broker does not envisage a one-notch downgrade will be an issue.

Without the benefit of asset sales, Credit Suisse believes the dividend pay-out ratio needs to fall to 70-75% to be cash neutral and observes the choice is between doing something in FY17 or smoothing the outgoings until profit grows. Morgan Stanley also considers a dividend reduction is inevitable. The company has signalled it does not operate a progressive dividend policy, aiming to grow dividends over time dependent on earnings, franking, liquidity and the credit rating. Given the outlook for these factors, the broker suggests a reduction in the dividend to $1.80 a share from $2.00 is likely in FY16.

Deutsche Bank takes up the call as well, believing management will take action to preserve the credit rating. Moreover, supply-driven fresh deflation should weigh on Coles while wet weather could also have a temporary dampening effect on Bunnings earnings. Deutsche Bank now assumes a final dividend of 89c versus $1.09 previously, an 18% reduction on the prior year.

The profit improvement strategy at Target appears straightforward to Credit Suisse, in that management intends to reduce the range as well as re-badge some stores as Kmart. Citi notes Target will follow Kmart, taking direct sourcing of product offshore to 70% of sales from the current 40%. Deutsche Bank considers the near-term outlook negative, with an additional $100m in inventory overhanging Target, but the longer-term strategy appears feasible.

Morgan Stanley asserts aspirations in terms of sales growth, margin and returns are the same as back in 2010 and the near-term looks challenging, given the excess stock that needs to be cleared and the fact that a third of stores are currently making a loss. UBS, on the other hand, gains more comfort from the briefing in terms of management's ability to turn Target around without adversely affecting Kmart.

A measured approach is being taken in the case of the UK expansion of Bunnings, with only pilot stores to be rolled out before Christmas. When those stores have been proven a full conversion will take place. Meanwhile, Credit Suisse observes better delivery from the integration of industrial and safety divisions, while brokers contend the resources division is not expected to significantly improve until coal prices turn higher.

FNArena's database has one Buy (Macquarie, yet to update on the briefing), six Hold, and one Sell (Citi). The consensus target is $40.48, signalling 0.7% downside to the last share price. The dividend yield on FY16 and FY17 estimates is 4.7% and 5.0% respectively.

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