Tag Archives: Consumer Staples

article 3 months old

No Need To Rush Into Woolworths


Bottom Line 28/09/16

Daily Trend: Neutral
Weekly Trend: Neutral
Monthly Trend: Neutral
Support levels: $22.28 / $20.50 - $19.76
Resistance levels: $26.05 / $28.03 / $29.22

Technical Discussion

Woolworths has interests in food, liquor, petrol, hotels and New Zealand supermarkets.  The latter is engaged in the procurement of food and liquor for resale to customers in New Zealand.  The hotel section is engaged in the provision of leisure and hospitality services which includes food, alcohol and accommodation as well as entertainment and gaming. For the year ending the 26th of June 2016 revenues decreased 1% to A$58.28B. Net income before extraordinary items decreased 15% to A$1.95B. Revenues highlight the Australian Food Liquor & Petrol section decrease of 3% to A$39.59B.  Broker/analyst consensus is a comprehensive “Sell”.  Dividend yield at today’s price sits at 3.4%.
 
Reasons to be cautious:
→ further asset sales feasible.
→ corrective action to the balance sheet should be dilutive for shareholders.
→ Speculation of a price war isn’t helping sentiment.
→ Continuing to lose market share in the grocery market.
→ Margins will remain tight and potentially decline further in the near term.
→ Analyst support remains negative.
 
We simply haven’t wanted to be involved in WOW from a trading perspective over recent months as the lacklustre price action continues. Having said that, a decent bounce commenced in early July this year resulting in a gain of just over 20%. However, it didn’t take long for the sellers to gain the upper hand again with price action off those highs being less than promising. If we are looking for small positives, then at least the recent pivot low terminated around the 61.8% retracement level as shown which in normal circumstances would be a bullish proposition. However, the retracement has hardly been textbook in regard to seeing a symmetrical 3-wave movement down.

That said, a push above the recent minor pivot high at $24.14 would be a small step in the right direction with a continuation up above $26.05 suggesting a larger bounce is going to unfold. In other words, there is plenty of hard work to be done before moving to a firmer bullish stance over the short- term. We think it’s much more likely that price is going to continue to meander sideways within a trading range between $20.00 - $26.00 for the foreseeable future. Some type of a basing pattern would be bullish bigger picture although they tend to continue for significant periods of time making for frustrating trading conditions. A push beneath $20.00 would be serious reason for concern although there has been very good demand at those lower levels in the past. All things being equal we’d expect this characteristic to continue. The risk at the moment is that price remains lacklustre while a larger base is built.

Trading Strategy

It’s still difficult to find a broker that is positive on Woolworths although of course this isn’t the be all and end all, even in regard to fundamental analysis. The general consensus appears to be that the company is going to slowly turnaround although it’s going to be a long drawn-out process. The recent rally likely prices in such a development which again means it’s difficult to get overly enthusiastic at this juncture. As long as buyers continue to step up to the plate just above the $20.00 mark, which is our expectation, there is scope for higher prices albeit much further down the track. We retain a neutral stance.


Re-published with permission of the publisher. www.thechartist.com.au All copyright remains with the publisher. The above views expressed are not by association FNArena's (see our disclaimer).

Risk Disclosure Statement

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Technical limitations If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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article 3 months old

Asaleo Care Facing Stiff Competition

-FX headwinds add margin pressure
-Dents stock's defensive reputation
-Emphasis on stable dividend payment
 

By Eva Brocklehurst

Asaleo Care ((AHY)) has issued a downgrade to its earnings outlook, as a result of intense competition and an inability to pass on higher Australian dollar pulp costs.

The company has suggested 2016 earnings will be down around 10%. The personal care business has historically generated high margins but rival Kimberly Clark has become more aggressive, Citi observes, taking market share. In the tissue category, many of the company's competitors are unlisted and can withstand recent pressure from a lower Australian dollar.

The broker notes Asaleo Care operates in a defensive category, but warns earnings are not necessarily defensive when competition heats up. A lack of revenue growth and persistent FX headwinds will add to the pressure on margins.

The 100 basis point decline in earnings margins in 2016 is unlikely to reverse and Citi notes that while the company called out $1m in one-off costs for its every day pricing initiative in 2016, the reality is lapping this initiative around May 2017 will hurt sales and earnings growth. Citi also cautions investors that more major supermarkets may add private labels in the tissue category.

Credit Suisse downgrades earnings estimates 16-20% because the price competition, which has been apparent since 2015, shows no sign of ebbing. In fact, the broker suspects competition will become even more severe in coming months. The previous optimism that cost savings could offset the revenue pressure has evaporated and the broker suspects the dynamics of the personal care category could remain problematic.

Kimberly Clark brand is battling in the number three market position. Asaleo is number two in toilet tissue behind ABC's Quilton brand and ahead of Kimberly Clark's Kleenex. Credit Suisse maintains, in mature categories such as this, the number three is at risk of a reduction in shelf space and private label substitution. Kimberly Clark Australia reported large losses in its Australian accounts in 2014 and 2015. Hence, the step up in competitive strategies.

Asaleo Care is directly affected by price competition in this area. In the nappy category in New Zealand the broker notes Kimberly Clark is the leader, yet the average retail price of its nappies has fallen 20% over two years. Savings in raw materials will accrue in 2017 as a result of pulp prices falling in US dollar terms but Credit Suisse assumes the industry passes savings onto consumers.

The only earnings growth the broker recognises in its models for Asaleo Care is the partial recovery of one-off restructuring charges. Still, despite the downgrade the broker expects the company to generate $63m in free cash in 2017 and pay $46m in dividends.

Citi notes the company's policy of re-distributing excess cash and balance sheet gearing is consistent with the target range in net debt. The broker envisages limited scope for the current buy-back to continue and expects greater emphasis on a stable dividend payment. The pay-out policy is 70-80% of earnings but a higher pay-out could be sustained, reflecting the free cash flow. Citi lowers earnings forecasts by 16% in 2016 and 17% in 2017.

Macquarie was expecting headwinds in the tissue category but that personal care – feminine hygiene, nappies – would be more stable. The competitive environment at the end of 2016 and into 2017 appears set to get tougher, with Asia Pulp and Paper continuing to try and grow off a small base and ABC commissioning a new paper manufacturing facility.

The broker considers the risk are to the downside and the magnitude of Asaleo Care's downgrade so early in the year highlights the competitive nature of the sales categories in which it operates. The broker believes this will dent the stock's defensive reputation and weigh on ratings for some time. The reinstatement of the buy-back, which has around $25m to run, after the results may be the next potential positive catalyst, Macquarie maintains.

There are three Hold ratings on FNArena's database. The consensus target is $1.58, suggesting 7.2% upside to the last share price. This compares with $2.03 before the downgrade to the earnings outlook. The dividend yield on 2016 and 2017 forecasts is 6.6% and 7.0% 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

Weekly Broker Wrap: Australian Dollar, Supermarket Suppliers And Banks

-Trade not influencing AUD value
-Official rate cut factored into AUD
-Woolworths struggling to improve sales
-Macquarie views ANZ returns sustainable
 

By Eva Brocklehurst

Australian Dollar

ANZ researchers have found little evidence that changes in Australia's trade composition have influenced the currency or the size of its risk premium. The analysts note the Australian dollar has been persistently overvalued relative to traditional commodity price models since 2010. The overvaluation was most extreme between 2010-13, which reflected foreign buying of Australian bonds because of relatively high rate spread differentials and absolute yields.

This came about at a time when the composition of Australian trade was evolving, with less reliance on cyclical resource exports. Services exports have risen sharply as a proportion of trade recently although these remain within historical ranges.

The analysis signals changes in Australian dollar valuations drive changes in the services balance but there is no converse link - changes in services do not drive the Australian dollar. The changing composition of trade cannot be responsible for the Australian dollar's resilience, the analysts maintain.

Rather, they continue to believe the persistent overvaluing of the Australian dollar reflects a heightened focus on sovereign rates in this cycle, rather than changes in the trade structure or broader vulnerabilities in the economy.

St.George analysts note risks to the outlook are broadly balanced and the Australian dollar is likely to trade within the mid US70c range for the remainder of the year. The analysts expect the Reserve Bank of Australia will reduce official interest rates again, observing this is largely factored into markets and the currency.

Downward pressure from a decision to reduce rates will be limited, in the analysts' view, given the easy monetary stances from other major central banks. While the US Federal Reserve may still rates rates this year the likelihood in the near term has lessened. Commodity prices are also unlikely to rally substantially, the analysts believe, given the modest pace of global growth. This underpins the view the currency will not trade far from the mid US70c range.

Strategy

The financial year has finished fairly flat for Australian equities, with the ASX200 index down 4.1% in FY16. Including dividends, the total return of the index was up 0.6%. UBS notes the fall in the return on the index was driven by a fall in earnings expectations offset by a small price/earnings multiple re-rating.

In terms of sectors, banks and resources underperformed and industrials outperformed, notably the yield sectors such as infrastructure, Australian Real Estate Investment Trusts (A-REITs) and utilities. Mega cap stocks underperformed while small-mid caps outperformed. UBS remains Underweight on mining, A-REITs and consumer staples, Neutral on energy and Overweight banks. The broker continues to have exposure to US dollar earnings and domestic cyclicals.

Supermarket Suppliers

For the first time in the UBS supermarket survey, Coles ((WES)) leads Woolworths ((WOW)) in all 26 sub categories. There were signs of better execution in areas such as fresh offerings and marketing and Woolworths is closing the gap to Coles. Yet, the survey found poor and deteriorating in-store compliance and internal culture are hurting the ability of Woolworths to translate its price investments into improving sales.

The risk of a price war grows, with suppliers forecasting shelf price deflation for the next 12 months. Suppliers were critical of marketing and in-store theatre and suggest Coles may need to invest more in operations going forward. Woolworths' average relative survey score did not improve, which suggests Coles will maintain its lead over the first half of FY17. Nevertheless, there are signs Woolworths is bottoming and UBS believes this could trigger increased investment from Coles to ensure top line momentum is maintained in a slowing market.

UBS expects Woolworths to still narrow the gap to Coles in the first half but acknowledges the survey does signal forecasts may prove optimistic. Thus a Sell rating is reiterated for Woolworths with a Neutral rating and negative bias for Wesfarmers.

Banks

The Australian Prudential Regulatory Authority has updated on the capital position of the major banks. The regulator believes, while the banks are in the top quartile of internationally active banks with an average CET1 ratio of 13.5%, the level of capital will need to continue increasing.

ANZ Bank ((ANZ)) is the only bank in Macquarie's view that should sustain its returns over the next three years, while the returns of peers are expected to decline by 11%. Forecasts currently incorporate $19-20bn of additional capital across the majors by 2019.

The broker continues to believe that in a low-growth environment, banks should be able to organically generate capital and maintain elevated pay-out ratios. Macquarie recognises some risk of further capital raising if banks are not prudent in capital management, if balance sheet growth exceeds expectations and/or if banks are reluctant to lower pay-out ratios.

Macquarie remains slightly Overweight the sector based on its relative yield attraction and expects share price weakness in the near term should political uncertainty continue.
 

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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

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

Insurance

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%.

ESG

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.

Banks

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.

Consumer

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

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.

Pureprofile

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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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

Weekly Broker Wrap: Aldi, Oz Equity, Builders And Aged Care

-Coles best at countering Aldi
-Oz market driven by PE re-rating
-Difficult investment case in building
-Confidence in aged care continues
-Maiden FY17 profit expected from NAN
-HUO benefits from major supplier problems
 

By Eva Brocklehurst

Aldi

Is Aldi unstoppable? This is the question UBS asks in assessing the opportunities in Australia for the disruptive supermarket chain. Based on its analysis, Aldi appears to be obtaining new customers at an accelerating rate. Driving the lift in penetration is increasing volumes of wealthier shoppers.

Despite this feature, the chain's share of basket has fallen, as shoppers express a view that Aldi is good for some things but not a main shop. The fresh category appears to be the main impediment to Aldi lifting its share of main shopping trips.

UBS expects Aldi will reach $10.6bn in sales by 2019, equivalent to a 15% compound growth rate and a doubling of sales since 2013. This will be supported by like-for-like sales growth of 3.0% per annum, further roll-out in the east coast and new regions in South Australia and Western Australia.

UBS forecasts, as a base case, Aldi's market share reaching 10% by 2019. The broker believes Aldi is winning sales from all retailers, but its like-for-like growth has slowed over the past 12 months driven by the “Every Day Value” strategy from Coles ((WES)).

Coles is judged to have grown both trips and share of main shop among Aldi shoppers over this period. In contrast, Woolworths ((WOW)) has seen both measures deteriorate. This suggests to UBS that Coles has been successful in minimising its share loss to Aldi. The broker also notes that even the independent grocers appear to have benefitted from the issues at Woolworths.

Australian Equity

Australia has outperformed global peers in the past six months and the market is up more than 10% from its February lows, Deutsche Bank observes, and this is largely driven by a price/earnings (PE) ratio re-rating rather than earnings. The stocks are now seen becoming a little expensive.

Resources appear to have driven a lot of the rise, with improved momentum in China. While high PE stocks have been key contributors, Deutsche Bank notes the PE re-rating has been largely in stocks which were not expensive relative to others in 2015 but broke away in 2016 to be 15% more expensive relative to history.

In screening defensive stocks and ranking them in terms of PE ratio relative to a six-year average, earnings revision momentum and dividend yield the broker highlights AGL Energy ((AGL)), Suncorp ((SUN)), Healthscope ((HSO)) and Stockland ((SGP)). Others that screen attractively are Coca-Cola Amatil ((CCL)), Estia Health ((EHE)), Mirvac Group ((MGR)) and Duet ((DUE)).

Builders

A more normal housing market is developing, Macquarie contends, compared with the conditions in 2015 when the fear of missing out featured in consumer behaviour. Underlying demand still is firm, despite some evidence of a pre-election lull emerging. The broker notes affordability remains an issue but positive fundamentals are underpinning growth.

In canvassing builder viewpoints the broker notes a peak in construction activity is still in the future with all citing good visibility for the next 12-18 months. Consulting engineers were starting to see a slowing in the early stages of the supply chain. Supply constraints are also broadening. While bricklaying capacity was under pressure a year ago this seems to have been alleviated.

Trades in short supply now include painters, formwork and joinery. In terms of the location, momentum in NSW is on par with 2015 while there remains some strength in pockets of the regional markets, the broker observes. One participant reported increasingly buoyant conditions in Queensland and expressed confidence in the Victorian detached market.

Materials pricing appears to be growing 4-6%. The overall investment case remains difficult, Macquarie maintains, as cyclical risks continue to grow. The broker continues to prefer offshore exposure with James Hardie ((JHX)), and maintains an Underperform rating on CSR ((CSR)) and Brickworks ((BKW)).

Aged Care

UBS is encouraged by the long-term prospects for the aged care sector despite the short-term earnings pressure. The broker calculates that a bed shortage over the next two years will drive occupancy rates up 200 basis points and occupancy is not expected to fall below 93% before 2020.

The broker expects financial pressure from the 2016 federal budget will stymie bed growth, with the larger operators continuing to invest but the smaller end likely to reduce planned investment as a means to conserve capital.

Industry operators are likely to react to the government's cuts to funding by increasing the co-payment for residents, via accommodation payments and additional services charges. UBS expects the tight supply will mean residential accommodation deposits (RADs) will continue to show strong value appreciation and suspects estimates of 5% annual growth are looking increasingly conservative.

Morgan Stanley expects low organic growth, noting the listed operators are confident that additional services revenue, scale benefits and cost management will partly offset the lower government funding and enable margins to be maintained. Still, the broker incorporates a small amount of negative leverage into its base case.

The broker observes there is a fair amount of time to deal with the budget changes but remains cautious and desires more confidence that the strategies to manage the difficulties in the sector are working.

Morgan Stanley prefers Aveo Group ((AOG)) in the sector, as the company is most advanced with its strategy in Australia, having had success previously in New Zealand. The broker also expects higher returns over the long term if the Aveo Way contract with Stockland becomes the norm, although does not incorporate this into its base case.

Nanosonics

Nanosonics ((NAN)) has now established Trophon as the standard of care for high level disinfection of ultrasound probes in Australia and Bell Potter observes it is quickly reaching a similar status in the US. The installed base of Trophon in the US is approaching 25% of the market.

The company is expected to generate a maiden full-year profit in FY17. Beyond the US and Australia a start has been made on key markets in Europe and the broker anticipates revenues will accelerate as the regulatory environment changes to embrace the broad adoption of Trophon.

The company is not expected to require further cash from shareholders, given Bell Potter expects it to be positive on cash flow in FY17, but the broker cautions that the investment does warrant a higher risk rating than more established industrial stocks. Bell Potter initiates with a Buy rating and $2.25 target.

Huon Aquaculture

A contraction of salmon biomass at sea in Norway and Chile, where major suppliers are confronted by algal blooms, sea lice and lower stocking rates, has resulted in a material contraction in global supply. Production is forecast to be down by 5-8% in 2016.

Huon Aquaculture ((HUO)) generated 90% of its revenue in export and domestic wholesale markets in FY15 which Bell Potter notes is where pricing has had a reasonable correlation to global import parity levels. Hence, the broker envisages Huon Aquaculture providing leverage to the continued improvement in global salmon prices.

Bell Potter retains a Buy rating, which it believes is supported by the completion of a significant investment in the asset base to deliver growth towards 25,000 tonnes of fish and a reduction in operating costs from the benefits of the recent capex program, as well as a more favourable pricing environment. The broker's target is $4.05.
 

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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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