Tag Archives: Consumer Discretionary

article 3 months old

Outlook Divided On Metcash As Challenges Continue

-Price match, refurbishments gain traction
-Healthy balance sheet, re-start to dividend
-Questions over supermarket competition
 

By Eva Brocklehurst

Brokers remain divided over the outlook for Metcash ((MTS)) as the company's FY16 results were broadly in line with expectations but suggest that challenges continue. The company provided no comment on FY17 trading to date other than confirming competition remains intense in food & grocery.

UBS makes modest downgrades to both grocery and hardware forecasts, which are offset by an upgrade in liquor forecasts. The broker expects increased pressure on the company-supplied supermarkets (IGA), as Aldi makes strides in South and Western Australia.

Moreover, UBS considers the stock is structurally challenged, facing significant headwinds despite the efforts taken to level the playing field in terms of price matching. Long-term market share and margins are expected to fall in grocery, putting pressure on earnings, a situation which UBS does not believe is reflected in the current share price. Hence, a Sell rating is maintained.

At the other end of the spectrum is Morgan Stanley with an Overweight rating, believing the market is being overly punitive. The broker argues that there is evidence price matching and the Project Diamond refurbishment initiatives are gaining traction. This is driving IGA retailer sales growth, and Metcash earnings declines should moderate with the cost cutting initiatives.

The broker notes the price matching initiative now covers 960 IGA stores, while refurbishments have been implemented in 150 stores to deliver a 16% sales uplift. Improving sales growth makes these IGA retailers more sustainable in a competitive supermarket industry.

Morgan Stanley acknowledges the company will bear the full force of the Aldi expansion in SA and WA in FY17 and believes tight management of costs remains as critical as ever. The broker expects the cost base should stay flat over the coming three years.

The most compelling outcome of the FY16 results was lower net debt, which the broker expects should reduce even further in FY17, as no dividends will be paid (a second half FY17 dividend would be paid in FY18) and working capital efficiencies and insurance proceeds will be banked. The company also continues to divest non-core assets and Morgan Stanley estimates that Metcash, as of FY17, will have the healthiest balance sheet across its consumer staples coverage.

Ord Minnett also hails the repair job on the balance sheet and the prospect of the dividend being reinstated from the second half of FY17, yet downgrades to Lighten from Hold as the competitive environment in the food & grocery business is expected to continue to drag on the share price.

The broker observes the core supermarkets division is performing well, agreeing that the price matching and Project Diamond initiatives have taken hold. Furthermore, Ord Minnett considers the Woolworths ((WOW)) Home Timber & Hardware business will be an attractive acquisition for Metcash, supporting its strong Mitre 10 division.

There is a realistic probability that Metcash will be successful in acquiring Home Timber & Hardware, Credit Suisse asserts, which should prove a significant addition to value. Post this acquisition, hardware and liquor distribution would comprise 40% of group earnings and create a more balanced earnings stream.

The broker's investment case (Outperform) is driven by the belief there is enough in cost reductions to offset the negative competitive impact on food distribution over the next three years, with the improved clarity on the expected FY17 savings of note. The broker suspects retailer profitability will be the main effect of the heightened competition from Aldi in SA and WA.

Supermarket earnings appear to be stabilising despite the difficult trading environment, Macquarie contends, while the corner shop/convenience earnings detracted from food & grocery's performance. The broker suspects convenience earnings, traditionally 17% of food & grocery sales and 7% of earnings in FY15, will struggle to break even in FY17.

Meanwhile, hardware and liquor are doing the heavy lifting and contributing to growth over the medium term as consolidation takes place. Macquarie accepts the company has a track record of disappointment and that market confidence needs to recover on the back of strong execution in operations to realise the full value of the stock.

Deutsche Bank agrees management is doing the right things to shore up its business but, despite some benefit from weakness at Woolworths, supermarket wholesale sales are still observed declining on an underlying basis. The broker fears sales could worsen when Woolworths sales eventually improve and as Aldi's roll-out continues. The cost reduction program is expected to be diluted by cost inflation, operating de-leverage and price investment.

FNArena's database has four Buy ratings, one Hold and two Sell. The consensus target is $2.02, suggesting 5.9% upside to the last share price. Targets range from $1.30 (UBS) to $2.51 (Macquarie). The dividend yield is 3.5% on FY17 and 6.5% on FY18 forecasts.
 

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article 3 months old

Treasure Chest: Potential In Kathmandu Turnaround

By Eva Brocklehurst

Kathmandu Holdings ((KMD)) intends to turn around its performance by improving operations and products, rather than relying on consumer spending or external factors. Yet brokers observe one external factor, the weather, is affecting the outdoor clothing and gear market at present.

The new CEO, Xavier Simonet, is revamping store lay-out, product design and inventory, while undertaking less predictable promotional strategies. These strategies are all expected to drive earnings improvements and growth from existing stores, rather than by opening new stores.

The company is dependent on three key trading periods, two of which are, or were, under pressure, Morgan Stanley observes. The timing of Easter earlier in the year - March instead of April - meant sales were affected and the warm start to winter has also curtailed consumer interest in buying protective outdoor gear.

The company has a strong brand in winter apparel, such as fleece, down jackets and knits and a number of other retailers have also recently suggested the warm winter has hindered sales. Canaccord Genuity suspects consumers may wait for the winter sales (late June), but acknowledges this could affect Kathmandu's winter revenue and margins.

Another aspect currently cooling Morgan Stanley's ardour for the stock is that the newly restructured Ray's Outdoors, owned by Super Retail ((SUL)), means more clearance activity from an emerging competitor. The broker recently downgraded Kathmandu to Equal-weight from Overweight.

Yet Canaccord Genuity is more confident that a turnaround is materialising. Management blamed a poor performance in FY15 on predictable promotional activity, being overstocked, a slowing in consumer spending and carrying higher debt levels than it had targeted.

Now, the broker observes, FY16 estimates reflect more positive momentum, with FY16 revenue of NZD437.6m expected, versus NZD409.4m in FY15, and profit of NZD30.4m versus NZD20.4m. Further improvements are expected in FY17.

Canaccord Genuity factors in a small number of new stores opening each year. Australasia has capacity for 180 stores, management maintains, compared with 160 currently. The broker suspects some poorly-performing stores will be closed each year but management has also assured the market it will not expand for the sake of chasing growth and will avoid cannibalising existing stores.

In discussions with management, the broker notes the company has an unofficial target for long-term debt around NZD40m, averaged through the cash-flow cycle. This compares with the peak of NZD70.9m reported in the first half result. Despite the headline, the company remains within its covenants and, based on its modelling, Canaccord Genuity believes the balance sheet will be within the target range by FY18. Then, capital management strategies may be considered.

The dividend pay-out ratio is currently 50-60% but management envisages an opportunity to raise that to 70-80% over the next few years, once debt levels reach the target. The broker forecasts a AUD7.6c dividend in FY16, based on a 51% pay-out ratio, offering investors a 5.5% yield, 50% franked. This increases to AUD9.2c in FY17, based on a 59% pay-out and offering a 6.6% yield, 50% franked.

Canaccord Genuity believes the stock is good value versus comparable specialty retailers, based on FY16 earnings estimates. If management can prove there is upside from operating efficiency within stores, and the international expansion can occur with minimal risk, then the broker suspects the market may re-rate the stock to a multiple closer to the market average. Canaccord Genuity initiates coverage with a Buy rating and $1.60 target.

The company currently operates 162 stores across Australasia and the UK and an online store. The brand manufactures and sells apparel, footwear and technical equipment targeting hiking, camping, snow, water sports and cycling markets. Canaccord Genuity notes the challenges in the industry include relatively flat participation rates for outdoor activities and the fact that consumers tend to head to gyms, running or yoga rather than traditional hiking and climbing markets.

To counter this trend the company has become more involved in the yoga and running markets and is also intent on bringing a higher level of fashion to its regular product range, as outdoor wear transitions to day wear. The adventure traveller has also become a key target in the technical ranges of apparel, luggage, footwear and accessories.
 

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article 3 months old

Challenges Mounting For Retailers

- Oz retail sales strong, currently
- House prices and rate cuts supportive
- Income growth negligible
- Housing boom temporary


By Greg Peel

What is a “normal” interest rate?

Effectively it is the level of cash rate a central bank can set that ensures an economy is neither overheating nor receding, but rather ticking along nicely at a “normal” pace. Which brings us to the next question: Are interest rate cuts always a good thing for markets, and hikes always bad?

If we consider the rally in the ASX200 which has occurred since the RBA’s surprise rate cut in May, and assumptions of further cuts to come, we would have to conclude yes: rate cut good, rate hike bad. But to take such a simplistic approach is to ignore the reason behind any change in policy, which is where “normal” comes in.

One of the sectors to enjoy the benefits of the May rate cut is retailers. The thesis is simple: Rate cuts mean lower mortgage payments means more money in punters’ pockets to spend, and lower rates mean higher house prices mean greater perceived household wealth means greater incentive to spend.

Consumer confidence duly rose following the May rate cut. But did anyone stop to think just why the RBA was forced to cut?

While Australian retail sales growth slowed in early 2016 to an annual pace of 3.6% over the year to April, for some time now retail sales growth has outpaced lacklustre underlying income growth, notes Deloitte Access Economics. Sales growth has instead been driven by rate cuts and rising housing wealth.

The Australian economy has to date offered strong resilience in the face of falling commodity prices and rapidly declining mining investment, but quite a toll has nevertheless been taken on national income growth. It is against this backdrop that the RBA announced its May rate cut. “Many of the challenges to the Australian economy to which the Reserve Bank is responding,” notes Deloitte, “are also challenges for retail”.

A rate cut might be seen as a form of stimulus, but if an economy needs such stimulus clearly there is something wrong with the economy. If a central bank raises its cash rate to levels above normal, it is to put the brakes on an economy growing too fast. If it works the central bank can then cut its rate again in order to prevent the economy slowing down too fast, but any rate above normal suggests a positive economic environment.

If a central bank raises its cash rate when rates are below normal, as in the Fed last December, the negative of a rate hike is outweighed by the positive implication of a recovering economy. If the cash rate is cut when already below normal, this implies a safety net but confirms the economy is in trouble.

If a central bank cuts its cash rate from historically low to historically lower, the economy is in quite a lot of trouble. Is this the appropriate time for consumers to rush out and update their wardrobes?

Deloitte notes the current 3.6% retail sales growth rate is being driven by non-food retailing, with clothing retailers and department stores the stand-out sectors in early 2016. Retail sales growth has been able to outstrip growth in income largely due to the willingness of consumers to run down their savings, Deloitte points out, assisted by a house price boom which provided a big boost to the housing wealth of many consumers. In addition, a boom in housing construction has encouraged spending on consumer durables, while a fall in petrol prices had diverted some income from petrol retailers to other retailers.

The difficulty now facing retailers is that many of these supports are temporary, Deloitte warns.

Many an analyst is assuming the Australian housing boom will soon slow. Further RBA rate cuts, if they are forthcoming, would prolong the boom but not prevent the inevitable. Already there are grave fears for an overheated apartment construction frenzy. When supply finally outstrips demand, prices will fall and construction will cease in their wake.

Oil prices have already rebounded considerably.

All the while the challenges to income growth are continuing, with wage growth remaining at record lows.

Real (adjusted for inflation) retail sales growth was 3.3% in 2014-15, Deloitte notes. Following that strong outcome, Deloitte’s analysts see growth slowing to 2.5% in 2015-16 and 1.9% in 2016-17.

At present, retail sales growth is balanced between outperformance in the non-mining states, particularly NSW and Victoria, and underperformance in the mining states, particularly Queensland and Western Australia. “But the likelihood is that housing markets will be less of a positive for retail going forward,” Deloitte warns, “meaning that retail sales growth may slow elsewhere through the year ahead, particularly in NSW and Victoria”.
 

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article 3 months old

Treasury Wine Is Not Blackmores

-Disconnect to valuation peers
-Asian margin differential unsustainable?
-UBS: hard to justify a Buy call
 

By Eva Brocklehurst

The Chinese thirst for Australian wine is substantial and growing. Treasury Wine Estates ((TWE)) has revealed demand for its premium wine brands is strong, in particular for the Penfolds and Rawsons Retreat brands being sold into that market.

Brokers are attracted to the increasing penetration of the Chinese wine market but several wonder whether the outlook has led to Treasury Wine becoming overpriced.

Credit Suisse has believed for some time that, with exports to Asia and China particularly strong, Treasury Wine could become unconnected to valuation peers in the spirits, wine and luxury goods businesses and trade like another Australian-China export consumer stock, Blackmores ((BKL)). Treasury Wine is now seen approaching the Blackmores price/earnings (PE) ratio on FY18 projections, yet the Blackmores business model generates much higher returns.

Has explosive growth in China led to an over-valuing of the opportunity? Citi suspects that is the case. When the company extends its reach in that market to other less recognised and lower-priced brands this should result in slower sales growth and compress earnings margins. The broker expects the wine volume to China could rise six-fold by 2030, with the biggest drivers for Treasury Wine being a greater share of Australian exports as well as per capita consumption growth in China.

Treasury Wine's volume share of Australian exports to China is around 7% but Citi believes it should be more like 14%, based on share in Australia. Outsized volume growth should persist for Treasury Wine until FY18, because the broker expects the company to be catching up to other Australian wine exporters to China.

Nonetheless, Treasury Wine's Asian margins are at 34% compared with a group average of 14% and the broker suspects the pricing difference is unsustainable. Given Australia and Europe are likely to be single digit growth markets and the company has a challenged brand position in the Americas, Citi considers the price/earnings premium is unjustified for the pace of growth and lowers its rating to Sell from Neutral.

Morgan Stanley recently downgraded to Equal-weight from Overweight, citing the recent outperformance in the stock and believing the improved outlook is now reflected in the share price. The performance also probably reflects greater confidence that management can execute on its plans, in China and the US in particular.

The broker is attracted to the increasing penetration in China and believes the global wine industry will benefit from a tighter wine cycle as supply continues to be withdrawn from the market. Morgan Stanley also suspects changes to China's eCommerce regulations will have little impact on Treasury Wine.

The broker trims earnings forecasts for FY16-18 by 5-6% as the Australian dollar has strengthened, on average, against the company's transactional currencies to date. Earnings are highly sensitive to movements in the currency. Morgan Stanley now reflects a rate of US73c across FY16 and US72.5c across FY17.

Credit Suisse downgraded the stock last month, to Underperform from Neutral, and agrees with Citi that growth in China is likely to be sourced from lower priced wines, meaning volume growth should exceed earnings growth.

The broker observes sell-side estimates call for earnings growth of 45% between FY16 and FY18 and this looks to be a challenge. The broker's forecasts incorporate 26% growth, recognising the integration of Diageo will not be easy. Both Treasury Wine's North American operations and Diageo brands were struggling at the time of the acquisition. Furthermore, the stock is expected to capture no further positive earnings movement from exchange rates.

UBS is in the Neutral camp, expecting China will continue to be a growth engine because of favourable market dynamics, while the company has successfully turned around an underperforming business with a credible and sustainable strategy. The broker expects management will be able to reinvigorate the Diageo business over the next two years.

Moreover, Treasury Wine is considered one of the few consumer-facing stocks under coverage that is capable of delivering double digit compound earnings growth on a 3-year view. While the stock is trading at a 65% premium to defensive comparables it looks fair value, and the broker acknowledges it would be difficult to justify a Buy call under its rating framework.

FNArena's database has four Hold and three Sell ratings for Treasury Wine. The consensus target is $9.03, suggesting 11.2% downside to the last share price. Targets range from $8.70 (Citi) to $10.00 (Morgan Stanley).
 

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article 3 months old

Treasure Chest: RCG Corp Presents Buying Opportunity

By Eva Brocklehurst

The share price of footwear distributor and retailer RCG Corp ((RCG)) has slipped back 11% over the past three months. Moelis suspects investor unease is centred on the uncertainty in the lead-up to the July 2 federal election and this is sapping consumer confidence.

Yet the latest economic data suggest retail spending remains firm. The Westpac Consumer Sentiment index increased 0.8% in May and footwear and other personal accessory retailing turnover rose 7.3% in April.

As a result, the broker views the dip in the share price as a reason to acquire the stock and reiterates a Buy rating and $1.85 target. Moelis forecasts FY16 earnings of $61.6m, above the company's guidance of $58-60m, supported by growth of 20% in sales in the Accent division. At the company's first half result, like-for-like (LFL) sales growth was reported to be 25% for Accent.

If the broker assumes management's guidance for “low double digit LFL sales for the remainder of the year” equals 10%, this implies a second half growth rate of 13.8%. In a variety of scenarios, Moelis still estimates FY16 earnings to be above management's guidance.

Accent will open an additional ten stores in the second half, of which at least two will be Vans stores. An additional 25-30 stores are to be rolled out in FY17. RCG also expects to be able to open an additional 80-100 Skechers stores over the next five years, taking the total to 120-140.

While apparel retailers suggest some softness in current conditions, the broker believes footwear is more robust. Consumers tend to prefer buying footwear in store rather than online because fit and comfort is critically important. Moreover, with the Australian dollar at around US72c, online shopping has become more expensive.

Also boding well is management's comment that returning customers were up 10% in the first half, with an improvement in the company's net promoter score. RCG has over 300 stores and exclusive distribution rights for 13 international brands. Surveys have shown that in terms of footwear, brand is important to the younger consumer. Moelis suggests this indicates customers are less likely to switch to another brand, even if it is at a lower price point.

Management expects FY16 gross profit margins will be in line with the first half, and the broker is in line with guidance on this point, estimating gross margins of 50.9% and earnings margins of 13.5%.

Another point on which Moelis believes investors should feel more comfortable is that the option to extend the Timberland distribution agreement for a further two years has been exercised, while discussions with VF Corp regarding a new long-term agreement have commenced. Discussions regarding a new long-term agreement with Stance are well advanced.

The broker also notes that Wolverine World Wide, the parent company for RCG brands such as Merrell, CAT Footwear, Sperry and Saucony, has stated that, among several other regions, Asia Pacific beat revenue estimates in the March quarter.
 

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article 3 months old

Small Retailers Feeling The Chill

-Garment retailers particularly vulnerable
-Morgan Stanley downgrades KMD, SRF
-Citi highlights appliance sector competition
 

By Eva Brocklehurst

Discretionary retailers are facing challenges. Easter was early this year, the weather throughout autumn was much warmer than usual and now there is a looming federal election to add to uncertainty.

Brokers also highlight deteriorating economic conditions, whereby the Reserve Bank may elect to cut official rates further later in the year. Morgan Stanley expects the RBA to cut the cash rate to 1.0% in a scenario which will not necessarily support consumer confidence.

The broker believes all these factors amount to negative pressure on small cap retailers at present. Retailers likely to be affected by the weather and the timing of Easter include Pas Group ((PGR)), Premier Investments ((PMV)) and The Reject Shop ((TRS)) and Morgan Stanley retains Equal-weight ratings on the three.

The most resilient in the current conditions are likely to be Burson Group ((BAP)) and Baby Bunting ((BBN)), the broker asserts, with both these carrying Overweight ratings. Burson, which sells vehicle parts, is rolling out new stores and has made wholesale acquisitions of brands which should ensure market share gains and growth are maintained. Baby Bunting is less affected by weather too, as it sells mainly hard goods, and apparel forms only 5.0% of its range.

The broker is less confident in the near term for The Reject Shop and Premier Investments but, overall, suspects company-specific opportunities – non-apparel Smiggle in the case of Premier - will prevail and drive significant growth in the next two to three years.

While clothing, and the lack of interest in purchasing winter attire, is more obvious for Pas Group and Premier Investments, The Reject Shop, which does stock some winter related product and downgraded earnings last year because of a warm May, has been shifting its ranges to reduce seasonality, the broker acknowledges.

Morgan Stanley is more negative, recently downgrading Kathmandu ((KMD)) to Equal-weight . The company is highly dependent on three key trading periods and two of these, autumn and winter, have been affected by the backdrop cited above.

Moreover, the broker envisages the restructuring at Ray's Outdoors, owned by Super Retail ((SUL)), signals clearance activity in the near term, and the emergence longer term of a new competitor for Kathmandu in the re-formatted stores, which target hikers and other outdoor pursuits.

The turnaround at Kathmandu, therefore, is expected to take longer. Morgan Stanley has also become more negative on Surfstitch ((SRF)), downgrading the stock to Underweight a few weeks ago.

Citi suspects the appliance category, while sound, is becoming more competitive. The broker has recently downgraded JB Hi-Fi ((JBH)) to Sell, level with its rating on Harvey Norman ((HVN)), believing the share prices do not reflect the earnings risks. Harvey Norman is facing sales pressure as JB Hi-Fi rolls out its Home segment while the latter is facing downward pressure on earnings margins as a result of the roll-out.

Citi also suspects there are risks for JB Hi-Fi in acquiring The Good Guys. While the process is at an early stage, the broker believes investors should focus on the returns on invested capital rather than the weighted average cost of capital as the measure to value the transaction.

If the acquisition does not proceed, a listed re-capitalised and corporatised The Good Guys is likely to grow materially and take market share from both Harvey Norman and JB Hi-Fi, Citi contends.

Why does the election affect retailers? Morgan Stanley observes the July 2 date is right in the midst of a key winter trading period. Moreover, the campaign is long and Myer ((MYR)) recently indicated it is expecting an impact on consumer sentiment, although acknowledges this is difficult to quantify.

The broker's historical analysis shows that there is a strong pattern around elections in terms of retailers. Share prices rally into an election and subsequently underperform. Morgan Stanley suspects that pre-election promises engender expectations of stimulus which are subsequently deflated.

Another headwind is pressure on the Australian dollar as a result of any forthcoming rate reduction from the RBA. Morgan Stanley forecasts US71c by the end of 2016 and US65c by end 2017. Stocks that sustain a substantial impact from currency given a large portion of direct sourcing and/or more elastic demand include Kathmandu, Lovisa ((LOV)) and Pas Group.

More broadly, the broker has assessed 18 consumer-facing stocks in terms of their diversity and supplier relationships, as well as management and governance. Of the above mentioned stocks, Myer and Kathmandu stand out in terms of gender diversity in employees and boards, while JB Hi-Fi and Surfstitch are poorer.

The broker notes, to date, only Woolworths ((WOW)), Wesfarmers ((WES)) and Pas Group have signed the Bangladesh Fire and Safety Accord for ethical sourcing, a key area of focus in the wake of the Rana Plaza disaster. Harvey Norman rates the poorest on the metric of governance, with just two of its nine board members being independent.
 

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article 3 months old

Wesfarmers Dividend Under Threat?

-Returns should improve with re-base
-Dividend yield appealing
-Yet will the dividend be re-based?
 

By Eva Brocklehurst

Wesfarmers ((WES)) has bitten the bullet on retailer Target and its Curragh coal mine, outlining large impairments which will be taken in FY16. The charges do not provide new information, Deutsche Bank maintains, given these two businesses have been operationally weak for some time. While not a positive development, the broker notes the perverse side effect is that returns will improve and profit will lift as a result of a smaller capital base.

Wesfarmers has suggested the impairments will not impact on the company's debt covenants nor the calculation of the final dividend.

Target will make a $50m loss in FY16 from clearance activity and lower gross margins. Restructuring costs of $145m will be incurred, relating to head office, supply chain and inventory. Target will take an impairment of $1.1-1.3bn on its books in FY16. Curragh will incur an impairment charge of $600-850m, driven by a slower-than-forecast recovery in long-term export coal prices and FX.

Otherwise, the medium-term group outlook is considered robust, supported by Bunnings and Coles. Ord Minnett believes these two businesses form the more attractive features of the conglomerate's offering, as well as the company's skilled cash management and a focus on returns. Valuation support is considered modest but the dividend yield and underlying earnings growth are appealing, given the few attractive investment options around.

While larger than expected, Ord Minnett was not surprised by the charges, but raises its rating to Hold from Lighten now the challenges facing resources and Target are well accounted for in the FY16 results. The broker notes early indications of the plan to turn Target around were provided and the discount department store industry is expected to remain aggressive in its clearance activity, adding downside risk to the sector.

Morgan Stanley suspects the next step will be a reduction in Wesfarmers' dividend. The dividend has grown each year since it was re-based to $1.10 in FY09 but the broker expects the weaker resources and Target earnings, as well as the relatively high FY15 pay-out, suggest it may be re-based in FY16. A dividend of $1.80 is forecast, reduced from the $2.00 delivered in FY15.

The broker lowers FY16 earnings estimates by 7.0% to reflect weaker resources earnings and the re-base of Target. Despite this, Morgan Stanley notes the relatively strong outlook for Coles and Bunnings, which now contribute around 80% of group profits. A suspicion that the dividend will be cut is doing the rounds at Citi as well. The broker also suggests the group may be due a downgrade in its credit rating, given funds from operations versus total debt are not improving quickly enough. Citi retains a Sell rating.

Credit Suisse makes no changes to its dividend assumptions and expects Wesfarmers to retain a pay-out ratio close to 100% for FY16. The broker observes most of the charges for Target are associated with the clearance of excess inventory and, therefore, have no negative implications for the business performance in FY17.

Credit Suisse assumes a one-year pay-back on staff redundancy and three-year pay-back on head office closures, implying $40m in cost reductions. There are also no cash flow implications from writing down the carrying value of Curragh and the broker suggests that a change in internal valuation might make for an easier divestment decision.

The performance of Target is disappointing but Macquarie notes the expected loss will be less than 1.5% of FY16 group earnings. The broker observes a positive sales trend across the main retail businesses of Coles, Bunnings and Kmart and retains an Outperform rating.

UBS lauds the company's strategy and market share gains but wonders just how much stronger the top line can grow in a slowing market, and believes it will be increasingly difficult for the company to maintain profitable top line momentum in Coles. The choice management faces, in the broker's opinion, is whether to focus on margin or top line growth in a competitive and deflationary trading environment.

On FNArena's database there is one Buy rating, six Hold and one Sell. The consensus target is $40.58, signalling 1.0% downside to the last share price. Targets range from $37.30 (Citi) to $42.61 (Macquarie). The dividend yield on FY16 and FY17 estimates is 4.8% and 5.1% respectively.
 

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article 3 months old

Weekly Broker Wrap: Macro Outlook, Consumer, Property, Hotels, Gas And Insurance

-Policy support needed for growth
-Consumer positive, despite election
-Declining A-REIT development returns
-War footing with hotels and online agencies
-Flaws in gas reservation policy?
-NZ insurance growth under pressure
 

By Eva Brocklehurst

Macro Outlook

Macquarie suspects the Reserve Bank of Australia will need to cut the cash rate further, to 1.0% from the current 1.75%. Recent weak inflation adds to an already subdued outlook and the broker's former risk case is now the base case.

Domestic demand appears weak and the broker perceives additional policy support is needed to sustain current household spending growth, as support from wealth effects wane.

Macquarie believes it will be harder now to generate and sustain inflation near the RBA's target of 2-3.0%. The broker lowers its long-run inflation target to 2.0% from 2.5% and long-run nominal 10-year bond rate assumption to 3.25% from 3.75%.

Macquarie forecasts a sub-2.0% 10-year bond yield forecast to reflect the new record low in the cash rate, but does not make significant downward adjustments to growth. Growth remains narrowly focused with resource exports the main driver, while domestic demand is muted and fiscal policy points to further consolidation.

The broker also expects the recent strength in the Australian dollar will have a dampening effect on the economy in the first half of 2016 and that further depreciation in the currency is required to secure the transition in the economy.

Australian Consumer

Deutsche Bank contends that elections are not that bad for retailing. The election drag on total retail sales growth is calculated to be a modest 30-40 basis points.

The mid year timing of the upcoming election should also be less of a negative because it won't disrupt Christmas trade, although the impact could be greater if a clear result is not forthcoming. The broker continues to believe the consumer is relatively positive, given low inflation in non-discretionary items such as petrol, rent and utilities.

Deutsche Bank believes Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)) will trade well because of the strong housing market, a favourable product cycle and the exit of competitors.

Australian Property

Morgan Stanley is questioning the pay-out ratios of retail Australian Real Estate Investment Trusts (A-REITs). Declining development returns are expected to lead to an increasing proportion of capex being used for maintenance purposes.

The broker suspects this may place downward pressure on pay-out ratios, which are currently among the highest globally. The most vulnerable is Vicinity Centres ((VCX) as the company has an expanding tail of underperforming assets.

These could result in further dilution to free funds from disposals beyond current guidance and, if the company reinvests capital into these assets on marginal returns, it will place downward pressure on the pay-out.

Morgan Stanley recommends a switch from Vicinity Centres to GPT Group ((GPT)) given its distribution is covered by cash and the growth prospects are superior.

Hotels And Internet

Hotels have ramped up their online push to reduce the growing share of online travel agencies. As a result, Morgan Stanley observes global brands such as Hilton and Marriott have demanded lower commissions and removed last room availability signs in online sites.

They are encouraging loyalty members to book direct in return for cheaper rates. These brands are then being pushed down in the online agencies' search order.

Given the shifts in the industry the broker expects both earnings and multiples are changing. At this juncture, the case can be made for either side being the winner but the broker envisages potential for 15-30% in share price impact, either positive or negative, for hotel brands and the agencies and this could quickly put a business model at risk or create a price war.

Domestic Gas

The ALP plans to introduce a country-wide gas reservation policy for future LNG projects, which would extend Western Australia's current policy to the east coast, with the intention to reduce the impact of rising prices for the manufacturing sector.

Ord Minnett doubts the efficacy of such a policy, given price increases have been mainly driven by cost inflation and not export parity. The broker believes the relatively high cost of transporting gas currently insulates the southern states from export parity prices.

East coast gas reserves increased to 47,000PJ in 2016 with most of the development underpinning the three LNG projects on Curtis Island. The broker believes the additional requirements on gas producers could stymie much needed reserve developments while east coast reserves are sufficient for just 7-8 years at current rates of use.

NZ Insurance

There is no joy in the trends for general insurance in New Zealand, Macquarie observes. General insurance growth is under pressure and pricing is competitive.

There have been a large number of new entrants in the market and these have focused on commercial lines. AWAC, BHSI and Ando have all been taking market share in commercial, resulting in price pressure.

Meanwhile, personal lines are highly concentrated. Outside of Suncorp ((SUN)), Insurance Australia Group ((IAG)) and Tower ((TWR)) there are few other carriers underwriting personal lines in the country. Macquarie notes IAG has the greatest relative exposure to NZ in general insurance stocks under coverage, at 47% of premiums.
 

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article 3 months old

Is Current Premium Justified For Dulux?

-Mixed reactions to H1 results
-Is premium justified with softer housing?
-Or is it defensive stock, longer term positive?
 

By Eva Brocklehurst

Duluxgroup ((DLX)) dominates the paints and coatings market in Australia with its well-known brands, yet the company managed further market share gains in the first half from the re-launch of its Wash & Wear paint range. Margins also expanded by 50 basis points in the half year.

This positive aspect largely offset the retail channel de-stocking emanating from Woolworths' ((WOW)) Masters and Home Timber & Hardware as well as contract losses with Mitre 10 in New Zealand, resulting in a 4.0% lift to overall earnings in the half.

UBS incorporates a paint margin of 17.5% from FY16. While this is historically high, the broker believes it is sustainable, given the changes to the product mix as well as market changes relating to the exit of Masters from the retail channel, which should ultimately benefit Dulux. The broker envisages limited free cash flow being generated in the near term, given investment in new paint capacity, and considers the stock is trading close to fair value.

Citi is upbeat, noting leading indicators remain positive in key markets, with new housing strong and existing housing resilient, although the commercial and infrastructure sectors are subdued. This broker believes the results were good quality, with the company taking share in a challenging market while exercising cost control.

Paints in Australasia remain the driver of the company's earnings, generating 73%, while Citi notes Garage Doors & Openers has consolidated operational improvements. The broker expects new product developments will enable the company to generate above-system growth, with a potential supplement from acquisitions. Citi believes the stock justifies the premium at which it trades, given the quality of the business.

Other brokers are more subdued. Deutsche Bank substantially so, viewing the results as low quality, boosted by lower expenses, as net operating cash flow declined 27%. Guidance may be maintained for underlying earnings growth in FY16 but Deutsche Bank expects investors to focus on the lack of operating leverage at this point in the housing cycle, retaining a Sell rating.

The deterioration in cash flow disturbed Ord Minnett as well. The broker concedes management has flagged a short-term correction in retail channels and, in the second half, alleviating some of the one-off impacts should mean continued modest growth.

Outside of paint, the performance was more patchy, CLSA agrees, but highlights the fact these businesses are only 8.0% of earnings and 5.0% of valuation. Short-term concerns may exist regarding top line growth in paints but the broker, not one of the eight monitored daily on the FNArena database, believes the stock is one of the most consistent in the market and retains a Buy rating with a $7.30 target.

Credit Suisse is underwhelmed, particularly given the decline in the construction and consumer products division, driven by a soft Parchem result and the Selleys brand de-stocking. The broker believes execution around costs is the key to the second half, with the current earnings profile warranting a below-market multiple at this point in the cycle.

Renovation activity is strong and housing turnover high. Interest rates are low and consumer confidence outside of mining is good. Despite all these positives, the broker points to underlying growth across the core business being estimated at just 1-2%. Hence, Credit Suisse considers the stock's premium generous, given the indicators suggest a slowing in key end markets.

House price growth and housing turnover are precursors to renovation activity and both these indicators have slowed. Moreover, the new home construction market is approaching its peak with just 12 months of activity suggested in the pipeline.

Furthermore, the broker contends input costs are now a headwind with raw material prices expected to grow. On this note, management's commentary marks a significant transition, in Credit Suisse's opinion, to inflation-style growth from a falling raw material cost environment.

Competition is also expected to heat up in FY17 with the entry of Sherwin Williams to Australia and using price to offset cost inflation may be difficult if Dulux wants to grow market share, Credit Suisse maintains.

Caution prevails at Morgan Stanley too. The broker envisages few risks to near-term expectations but further afield expects a weakening housing market will flow through to Australian paint volumes.

Management is exploring offshore opportunities outside of Asia and part of this plan is looking to leverage the relationship with Wesfarmers ((WES)), as that company launches its Bunnings business in the UK. This makes sense to Morgan Stanley, given the recent large investment Dulux has made in expanding Australian paint capacity. Still, the broker perceives limited earnings growth in FY17 and FY18 and retains an Underweight rating.

While management is confident, Macquarie is cautious about competition, suspecting the merger of Sherwin Williams with Valspar could have medium-term impacts for Dulux. Meanwhile, Parchem is battling soft conditions in the engineering and infrastructure segment. Dulux does not expect increased infrastructure spending to translate into higher demand until 2017.

Macquarie observes the outlook is driven by margins, with Paint & Coatings margin improvement expected to carry through FY16 as disruptions in the New Zealand channel are normalised. The broker contends the market share growth in renovations in Australia stands out in the context of an increasingly crowded market, demonstrating the company's success with new product launches.

Despite taking a neutral stance on the stock for the short term, Morgans remains positive about the longer term, given strong brands and relatively defensive earnings, and would look to reconsider its view on any share price weakness.

There is one Buy rating (Citi), three Hold and four Sell on the database. The consensus target is $6.10, suggesting 4.3% downside to the last share price. Targets range from $5.20 (Deutsche Bank) to $$6.99 (Citi).
 

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article 3 months old

Super Retail Cranks Up Restructuring

-All divisions reporting sales growth
-Ray's Outdoors to become RAYS
-Infinite Retail also restructuring
 

By Eva Brocklehurst

Super Retail ((SUL)) continues to weed out underperforming businesses, with its restructure plans accelerating over the next 12 months. Brokers approve of the plans and welcomed the trading update, which suggests all divisions are lifting sales.

Ray's Outdoors will be re-branded to RAYS, largely representing the format which has been trialled over the past 12 months. From the existing 55 Ray's stories, 17 will be converted to the new format by October 2016. Of the remainder, 11 will be re-branded as BCF, three as Amart and one as Supercheap. The rest will be either re-branded or closed. All this is expected to be completed by February 2017.

Management expects $110m of the $135m of Ray's revenue can be retained in its leisure division. The earnings benefit from closing the loss-making stores is forecast to be $8m, with 75% realised in FY17. No assumptions on incremental margin uplift within Ray's or BCF are made but management is targeting RAYS sales revenue to reach similar turnover to BCF. This implies a turnover increase of around 30%.

Morgans takes a conservative position on the outlook, given the recent trials of RAYS have only been operating for less than a year. The broker notes costs associated with the restructure are significant and will make for a messy FY16 report but supports the strategy, as well as the harder line the company is taking with the Ray's Outdoors business, which is expected to make a substantial loss in FY16. Deutsche Bank also notes the initiatives, while welcome, are far from certain of success and the company is deploying a lot of capital to support growth.

Macquarie had considered a complete closure of the Ray's chain was a possibility. The leakage of just $25m from the sales generated from Ray's is the key risk the broker observes in the company's financial assumptions.

Super Retail will also restructure Infinite Retail, as it has been a drag on its sports division. Management is seeking to renegotiate some unprofitable contracts, largely with sporting bodies and clubs, and align the Rebel and Infinite IT platforms. Infinite Retail is expected to post a $5m loss in FY16, before breaking even in FY17 and contributing $25m in revenue. All up, Macquarie believes the initiatives will mean FY17 shapes up as a better year for growth at Super Retail and upgrades to Outperform.

Trading at the start of 2016 has been strong with like-for-like sales up across all divisions. Automotive accelerated to 5.8% from 4.0% in the last 10 weeks of the third quarter, while sports strengthened to 6.4% from 5.5%. Leisure sales are up 4.5% year to date. Margins within the automotive and sports divisions are higher, while leisure is affected by lower pricing, higher costs and inventory clearing.

Profit upgrades associated with the initiatives are better than Morgan Stanley expected. The broker lifts earnings forecasts to account for reduced losses from Ray's, while noting the sports and automotive segments have market-leading positions and are well placed for growth. The broker finds the stock's valuation even more attractive now, given the earnings outlook has improved.

UBS believes the stock is screening cheaply on risk/reward basis and expects investor sentiment will improve as the benefits of the restructuring become evident. Over the medium term the broker considers the growth story is intact, with continued momentum in automotive and sport, margin recovery in leisure and a stronger cash flow. UBS suspects the strong balance sheet will provide scope for capital management in FY18.

There are four Buy ratings, three Hold and one Sell rating on FNArena's database. The consensus target is $9.51, suggesting 0.6% upside to the last share price and compares with $9.27 ahead of the update.
 

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