Tag Archives: Insurance and Finance

article 3 months old

Silver Chef Gets The Bronze, For Now

- Silver Chef's growth story remains intact
- Accounting change impact
- Brokers await impairment clarity

By Greg Peel

Equipment leasing and financing provider Silver Chef ((SIV)) has reiterated FY16 profit growth guidance of 20-26%, and offered initial FY17 growth guidance of 19-23%. FY17 guidance is well short of the forecasts of the two FNArena database brokers covering the stock -- Morgans and Macquarie.

On face value, the shortfall reflects greater than expected costs for the company’s expansion into Canada and a more conservative approach on bad debt provisions for the GoGetta business. In both cases, the brokers are not hugely concerned. Both see Canada as offering material long-term growth, while Morgans suggests the significant volumes being written by GoGetta mean greater provisioning is not a surprise.

There is also an accounting element to the effective FY17 downgrade, which both brokers acknowledge. Because of those significant GoGetta volumes, Silver Chef has decided to now amortise the cost of lease origination over the initial term of the lease as opposed to expensing upfront, as has been the policy previously. This effectively means a re-basing of FY17 earnings and thus an element of the downgrade can be attributed to the change.

Macquarie notes the new policy meets with accounting standards and the broker has no qualms.

In short, both brokers still see a company with a very strong underlying growth rate and promising longer term potential. In the nearer term, both would like to see more clarity around the greater GoGetta provisioning and thus await further detail in Silver Chef’s upcoming FY16 result release.

In the interim, both brokers have trimmed FY17 earnings forecasts and decided that after a very strong share price run (notwithstanding yesterday’s price plunge) it would be sensible to pull their recommendations back to Hold (Neutral) from Buy (Outperform).

Morgans has cut its price target to $10.40 from $11.00 and Macquarie to $9.53 from $10.49.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Treasure Chest: Cover-More Shakes Off Uncertainty

By Eva Brocklehurst

The protracted underwriting issues experienced by travel insurance provider Cover-More ((CVO)) over recent months have diverted attention from the stock's key investment thesis, the outlook for outbound travel. Now there is some clarity in this regard, Bell Potter believes it is time to look at the company's margin trajectory and exposure to the travel theme.

The company has finalised an underwriting arrangement with Great Lakes Australia in the interim while a new underwriter is obtained. The term will run until September 30, 2017. The company is able to terminate the deal on reaching an agreement with new underwriters, with notice of intent to be provided 3-6 months ahead of termination. The target loss ratio is unchanged. A new underwriter agreement is expected to commence no later than January 2017.

Bell Potter is now increasingly confident earnings margins for Australian travel insurance will gradually move towards the company's stated guidance of 7.5-8.0% of gross written premium over time. The company provided this guidance prior to the resolution of the underwriting arrangement and the market has attached little credence to the likely delivery.

Now some clarity has been provided, the broker expects the improving margin outlook over the next two years will increasingly be heeded. Bell Potter assumes the process will be gradual, as the impact of premium re-pricing takes time. Still, the main point is that the trajectory in margins is likely to be up.

The outbound holiday theme is also an appealing aspect of the stock, a theme which has been set aside while the machinations of underwriting play out. Bell Potter finds this is one of the main attractions in Cover-More, given its domestic travel insurance business is leveraged to volume growth in this variable. The broker expects a structural shift to outbound travel at the expense of domestic will continue, and the finalising of the underwriting agreement is a positive step towards restoring market confidence.

A combination of favourable age demographics and downward pressure on airfares provide powerful tailwinds for the segment in the year to come. The broker believes the recent slowing in outbound travel is indicative of a slowdown in household consumption expenditure, as part of a correction within a long uptrend.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Buy rating and $1.86 target. The broker believes Cover-More's tourism exposure is enhanced by the light capital nature of the business and a solid balance sheet with an increasing dividend stream.

This interim arrangement will lift the alignment between Cover-More and Great Lakes and reduce volatility in underwriting premium, UBS concurs. However, the broker notes that Cover-More will share in both the upside and downside of claims cost experience versus the target loss ratio, compared with the prior arrangement when Great Lakes took the downside risk.

The main question relates to the flow through of any new deal to insurance margins. The current share price appears to be factoring in margins of around 5.0% in perpetuity and UBS suspects the market will retain a cautious stance until new underwriting details are signed off.

There are two Buy ratings and one Hold for Cover-More on FNArena's database. The consensus target is $1.79, suggesting 37.7% upside to the last share price. The targets range from $1.50 (Morgan Stanley) to $2.00 (Macquarie). The dividend yield on FY16 and FY17 estimates is 4.8% and 5.7% respectively.

Short traders have increasingly moved in on Cover-More in recent weeks. The latest ASIC data has shorts on Cover-More rising to 9.4% as of last week, leaving the stock exposed to short covering potential. (See The Short Report)

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

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.


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.


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.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

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

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


By Eva Brocklehurst


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

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

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

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

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

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

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


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

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

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


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

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

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

High Conviction Stocks

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

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

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

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


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

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

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


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

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

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


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

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

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Brokers Mull Impact of Brexit On Macquarie Group

-Earnings now more annuity style
-Impact on market-linked assets
-AUD movements crucial


By Eva Brocklehurst

In the fallout from the Brexit vote several brokers believe it only natural that investment bank Macquarie Group ((MQG)) will re-base 2017 expectations, probably at its July AGM. Bell Potter believes, just purely based on FX movements since March, profit is likely to be 3% lower across the forecast horizon.

Around 24% of the group's income is generated in EMEA – Europe, Middle East and Africa. Assuming the latter two are immaterial, Bell Potter estimates two thirds is from the UK and the remainder from Europe. Morgan Stanley calculates EMEA accounts for around 18% of Macquarie's total assets under management. Both brokers highlight the fact the majority of the company's investments in Europe/UK are in essential specialised infrastructure funds.

Hence, this does not justify a 12% pull back in the share price in the past week, Bell Potter maintains, given the largely defensive nature of the underlying assets in that region, and the de-risked annuity-style businesses. The broker, not one of the eight monitored daily on the FNArena database, remains content with a strong Buy rating.

In sum, Bell Potter lowers profit estimates by 6%, with half this downgrade attributable to FX translation and the rest to lower yields and market volatility. The price target is lowered by a similar magnitude, to $83 from $88. The stock remains one of the broker's high conviction calls given the long-term growth potential and sector leading positions in terms of capital, funding and liquidity.

To highlight the difference with the circumstances in the wake of the global financial crisis, Bell Potter notes the GFC affected the company most in 2009. In that scenario its total income declined by 33%, largely from asset and equity investment write downs, and real estate banking and proprietary trading losses.

The fact that annuity-style components now contribute around 60% of total income and around 70% of net profit underscores the current de-risked operating model, in the broker's view.

Morgan Stanley suspects the British vote could affect the firm via the impact on asset values and operating conditions in its market-linked business and also envisages downside risks to FY17 estimates. Management has stated it expects a “solid principal realisation pipeline in FY17” but this is considerably more challenging in the short term, the broker suggests. On the other hand, market volatility may improve the prospect of performance fees from the infrastructure funds.

The broker calculates that every 10% fall in the Australian dollar reduces Macquarie's earnings by 7%, noting the AUD/USD fell 2% while AUD/GBP and AUD/EUR rose 6% and 1% respectively in the wake of the vote. This implies a net impact on earnings of less than 0.5%.

That said, Morgan Stanley's cross asset analysts believe Britain's decision to leave the EU is a negative for risk premiums and, even though Macquarie Group has a diverse mix of businesses, the market is reminded that around 60% of revenue is linked to markets or asset prices.

Brexit will probably make the task of replicating FY16 even more challenging, Citi agrees. Yet this broker is much more bearish about Macquarie Group's outlook, suggesting market turmoil usually corresponds with a fall in earnings.

The broker suspects, while infrastructure funds may be a beneficiary of the lower-for-longer interest rate settings, near-term performance fees are likely to fall in FY17 as a result of the absence of large, unlisted maturing funds.

Citi also notes revenue was boosted significantly in FY16 by the accumulation of gains on asset sales, yet the uncertainty brought about by a UK withdrawal from the EU will probably mean a continued reduction in global merger & acquisition activity.

The broker also believes the share price could unravel beyond the trimming of earnings estimates, as the stock's rating unwinds. Valuation will likely be driven by market liquidity conditions and the performance of the Australian dollar and Citi suspects the stock may drift back to its $59 target.

The database has four Buy ratings for Macquarie Group, two Hold and one Sell (Citi). The consensus target is $72.28, suggesting 4.9% upside to the last share price. Targets range from $59 (Citi) to $85 (Credit Suisse). The dividend yield on FY17 and FY18 forecasts is 5.7% and 5.9% respectively.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

REPEAT: What’s Ahead For Australian Banks?

This story was originally published yesterday, but due to a technical error it was cut well short of its intended length. This is now being rectified by republishing it in full.

- The Brexit fallout
- Stiff competition
- Margin downside
- Capital concerns


By Greg Peel


Before the Brexit debacle, an interesting juxtaposition had opened up between major banks across the Pacific. US banks had rallied on the expectation of rate hikes, and Australian banks had rallied in the expectation of rate cuts.

The share prices of banks in both centres had fallen sharply earlier this year in sympathy with European banks, which were hammered due to their exposure to emerging markets. China, in particular, was clearly slowing, but the plunging oil price had sent the economies of the likes of Brazil and Russia into a tailspin.

Deutsche Bank managed to arrest what looked like a slippery slope for all European banks by buying back a big chunk of shares. The oil price then began to improve, and disaster was averted. This allowed bank investors in both the US and Australia to refocus on domestic issues.

In the US, expectations of a pending Fed rate hike grew. The central bank itself was still tipping up to three hikes in 2016. While US banks had become comfortably well capitalised in the post-GFC years, near-zero interest rates had meant little chance of decent earnings growth given low net interest margins. The prospect of Fed rate hikes was thus positive for US bank shares.

Bank valuations are a proxy for an economy, but more specifically, stronger economies mean higher interest rates, more credit demand, wider net interest margins and thus greater earnings. Yet in Australia, the story was flipped over.

Australian bank shares took a turn for the worse last month when bank profit results revealed a big jump in “single name” bad debt provisions, as well as concern for loan quality in the mining states. Selling soon quickly turned into buying nonetheless when the March quarter CPI result showed signs of disinflation and the RBA caught all by surprise with a swift rate cut in May. Economists immediately began to factor in two to three more RBA cuts ahead.

But if rate hikes are good for US banks, why are rate cuts good for Australian banks? Well, they’re not…in terms of net interest margins and profits. But rate cuts are good at easing pressure on bad debts, and in Australia’s peculiar mortgage world, in which 25-year loans are priced off the overnight cash rate, rate cuts provide the opportunity for Australian banks to “reprice” their variable rate mortgage books by not passing on all of the cut.

At least some earnings growth is thus created.

The rally in US banks helped the S&P500 back to all-time highs. The rally in Australian banks helped the ASX200 back to resistance at 5400. But then along came Brexit.

The Fallout

When the shock Brexit result became apparent, all global bank shares were sold off in a hurry given global financial uncertainty. The UK and European banks understandably copped the brunt, with share prices falling 15 to 20+ percent.

The big-name US investment banks have various levels of exposure to UK earnings. For Goldman Sachs for example, 20% of earnings is derived in Britain. It thus makes sense banks should be the worst performers in the post-Brexit sell-off on Wall Street, dropping 5.4%.

National Australia Bank ((NAB)) will have been breathing a serious sigh of relief last Friday that the Clydesdale Bank spin-off was done and dusted ahead of the Brexit vote. The Australian financials sector fell 3.8% as a whole on Friday. NAB fell 4%. CYBG Plc ((CYB)) fell 17%, and is still falling today. Take the Clydesdales, Henderson Groups and company out of Friday’s financials sector fall, and Australia’s major banks did not fall anything like the UK, European or even US banks.

With good reason. While Brexit has undeniably unleashed global uncertainty, and the nemesis of stock markets is uncertainty, Australia’s banks have minimal exposure to UK/Europe and offer solid yields in a growing economy.

But it’s not all wine and roses for the Aussie banks looking forward in domestic isolation. A glance at the following table reveals the majors are all facing falling earnings growth and dividend pressure. The other element that leaps out is the large gap to stockbroker target prices, with Commonwealth Bank’s ((CBA)) traditional premium still evident, but the table is based on Friday’s closing share prices and stockbrokers will now need to reassess their valuations.

In FNArena’s experience, when gaps to bank share price targets get this large, one of two things has to soon give. Either bank shares rally or analysts downgrade their targets. The question now is as to whether analysts will see a need to downgrade their targets due to something that has happened a world away. They may nevertheless need to downgrade based on the uncertainty factor and what analysts will call “reduced multiples”.

This is code for “the banks have been sold off so now our target looks a bit rich”.

But before there was Brexit, there was the Australian domestic banking scene and its own issues.

The State of Play

Earlier this month, Macquarie’s bank analysts “went shopping” to assess the state of the local mortgage market in the wake of stricter investment lending regulations, mortgage repricing, an RBA rate cut and the need to preserve capital.

The analysts found that there now appears to be a greater level of consistency across the banks compared to last year’s significant variability in borrowing capacity. On average they found lending capacity had declined by around 10% compared to twelve months ago, reflecting tighter lending standards.

Yet that said, international comparison found lenders in the UK and US appear to be more conservative. Talks with mortgage brokers revealed competitive mortgage discounting of an average of 140 basis points off published rates among the Big Four. Given that level of discounting, Macquarie estimates mortgage “front books” (new) are averaging a net 14% return on bank tier one capital, averaged across owner-occupier and investment loans, compared to 30% across mortgage “back-books” (old).

Such a pricing trend does not bode well for banks’ future returns, Macquarie points out. The analysts believe the banks will either have to start competing less aggressively or put more emphasis on cost-cutting if they are to preserve future profitability. If not, Macquarie sees some 13% impact on valuations even if a further 25 basis points of mortgage repricing is passed through to customers.

That said, the broker remains “slightly overweight” banks given relative yield attractiveness in the low interest rate environment.

Bank analysts agree the majors will probably look to further mortgage repricing once the federal election is out of the way – they do not want to draw any further electoral antagonism beforehand – and will no doubt reprice if further RBA rate cuts are forthcoming. This should provide some earnings stability in the next 6-12 months, Bell Potter contends, but the low interest rate environment is expected to persist for some time and will continue to dampen bank margin expectations.

At the macro level, tighter prudential and home lending constraints on banks suggests credit growth closer to two times the GDP growth rate compared to a 12-year average of three times, Bell Potter notes.

Standard variable rate (SVR) mortgages account for 80-85% of Australian home loans and an even higher proportion of new loans, Morgan Stanley notes – 90% at CBA and 87% at Westpac ((WBC)). One might expect borrowers would be looking more closely at fixed rate mortgages, despite possible further RBA cuts, given an historically low cash rate. But the banks were onto that game early, lifting the premium on fixed rate loans over SVRs.

The major banks have repriced their SVRs on average by 22 basis points for owner-occupier loans and 45 basis points for investor loans since May last year. However, the margin benefit derived is being eroded by aforementioned competitive discounting of up to 140 basis points for owner-occupiers. Thus Morgan Stanley is forecasting flat bank margins ahead, even after further repricing post-election and as a result of further RBA cuts.

On consensus estimates for price to earnings, price to book value, return on equity and dividend yield, Australian banks do not look expensive, Morgan Stanley declared, ahead of the Brexit sell-off. But such forecasts assume the status quo, and the broker believes risks remain skewed to the downside given weak income growth, falling investment and reliance in ongoing strength in the east coast housing market.

Margin pressures and increasing loan losses are key areas to watch, as well as dividend payout ratios. These remain elevated and further bank capital building is expected to be required from 2017, Morgan Stanley warns.

Impairment charges for bad and doubtful debts (non housing loans) moved to 54 basis points in the first half 2016 from 39bps in FY15, reflecting aforementioned “single name” and other specific areas of loan pressure. Morgan Stanley expects this measure to rise to 73bps in FY17 due to ongoing problems in the “pockets of weakness” and a mild deterioration in in broader business and consumer credit quality.

Then there’s the issue of capital, which has been hanging over the banks for some time. Despite having significantly lifted their tier one capital ratios from pre-GFC levels, the banks are awaiting a final decision on international “too big to fail” requirements and a final qualification of what APRA’s interpretation of “unquestionably strong” will be. The bottom line is the banks may need to increase capital to satisfy international rules and then add a further capital buffer to keep APRA happy.

Leading up to the May results season for the banks there was much anticipation of a reduction in bank dividend payout ratios as a form of capital preservation. A couple of years ago when the fallout from the GFC had eased and lofty bad debt provisions were no longer required, the banks were able to pay out higher and higher dividends and even pay special dividends in a race to see who could look the most attractive to investors looking for yield. But this year has seen bad debts back on the rise.

Yet only ANZ Bank ((ANZ)) has to date reined in its dividend payments. When Westpac and NAB did not follow suit during result season, there was much shareholder relief. But for bank analysts, it was only a matter of time. Earnings growth was slowing but already elevated payout ratios were by default still growing. Morgan Stanley has long been one broker convinced another round of bank capital raisings is ahead of us, and dividend payouts will have to come down beforehand to minimise the damage.

That said, the events of this past week have very much put global banks in the spotlight. Australia’s major banks enjoy steady loan growth, Morgan Stanley notes, high returns in retail banking through oligopoly mortgage pricing power, ongoing access to offshore funding, some flexibility of cost management and attractive dividend yields vis a vis cash rates. But the broker retains a negative stance on the sector, believing a better economic outlook is required before a more bullish stance can be taken.

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.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Weekly Broker Wrap: Financials, Health, Strategy And Insurers

-Growth spurt expected in managed accounts
-Are health care stock valuations more reasonable?
-Equity correction restores overall value, not relative
-GI has fewer constraints, distractions versus banks


By Eva Brocklehurst

Financial Disrupters

Morgan Stanley believes the business models of wealth and asset managers face disruption from managed accounts/separately managed accounts. Managed accounts are considered better at cornering customers because they meet more of their needs than managed funds. This drives higher flows and market share towards progressive industry players.

The broker contends that managed account business models centre on the retail customer not the product manufacturer and this is driving disruption. A tipping point is signalled between 2015-20, with managed accounts expected to grow funds under administration at a 35% compound rate, to $60bn, in which case they could deliver around 75% of industry flows.

Winners in this tussle are considered more likely to be the wealth managers, as opposed to asset managers, as financial planners seek to deliver more value to customers. While progressive asset managers are expected to grow earnings, Morgan Stanley envisages headwinds for Platinum Asset Management ((PTM)), downgrading the stock to Underweight from Equal-weight.

Among wealth managers IOOF ((IFL)) is in a fragile position, the broker contends, although the risks are largely factored into the price. BT Asset Management ((BTT)), on the other hand, is considered well placed for growth.

Health Care

The renewal of enterprise bargaining agreements (EBAs) for nurses in Victoria should mean that accelerating wage inflation is the largest single cost for hospital operators until FY20, Morgan Stanley contends.

The broker notes the structure of salary increases is intended to accelerate Victorian public sector nurse wages growth to bring them into line with NSW peers by 2020. Public sector wage have served as state-wide benchmarks for private hospital wage increases in the past.

Ramsay Health Care ((RHC)) and Healthscope ((HSO)) are both due to renew their Victorian EBAs this year. The broker's scenarios suggest valuation downside of around 4% for Healthscope and less than 1% for Ramsay.

While incrementally negative, given the agreements would run over the next five years, a signing of the proposed EBAs would create certainty on a significant portion of employment costs for the hospitals, Morgan Stanley acknowledges. The broker envisages two possible offsets to the impact to earnings. These are a continuation of the lowering of the skill mix and greater funding for nurses from private health funds.

Credit Suisse observes multiples for Australian listed health care companies have re-rated over the past few months. While are number are trading at levels ahead of historical averages, valuations appear more reasonable to the broker on a relative basis, given the commensurate re-rating of industrial stocks.

The broker assesses stock-specific multiples and, overall, finds CSL, Cochlear ((COH)), Sonic Healthcare ((SHL)) and Sigma Pharmaceuticals ((SIP)) are expensive relative to their respective global sub-sectors.

Ansell ((ANN)), Australian Pharmaceutical Industries ((API)) and ResMed ((RMD)) appear inexpensive, while Healthscope, Primary Health Care ((PRY)) and Ramsay are considered fair value. The broker's preferred exposures remain Ramsay, where fundamentals are intact for medium to longer term growth, and ResMed, which is underpinned by a strong market position.

Equity Strategy

ASX20 stocks have underperformed over recent years and Macquarie suspects this will not end until relative earnings growth and the return on capital differentials begins to stabilise, and ultimately improve. If these stocks were to test the relative performance low seen in 2000-07 then the broker suggests they need to fall another 15%. The deterioration in fundamentals this time, nonetheless, signals this may not be the current floor.

The stocks, or mega caps as the broker calls them, are no longer high relative return-on-equity stocks and within this group the only ones that are substantially over earning are the banks. Structurally, Macquarie considers these stocks are de-rating candidates, as long as relative growth and return on capital continues to decline.

CSL is considered most likely to remain an under-earner while Transurban ((TCL)), Westfield ((WFD)) and Scentre Group ((SCG)) are considered most likely to normalise back to earnings weightings, rather than retain relative growth status, outside of further declines.

The broker's preferred stocks in the mega cap space are CSL, Transurban and Westfield. Outside of mega caps Macquarie highlights Amcor ((AMC)), oOhMedia! ((OML)) and Aristocrat Leisure ((ALL)).

UBS observes the equity correction recently has restored some value to the market overall but has done little to restore relative value within, given already expensive defensive sectors held up somewhat better than the rest.

The rising risk aversion is exacerbating stretched valuations, in the broker's opinion. Defensive yield segments at the same time, best represented by the real estate investment trusts (AREITs), are still looking relatively expensive, but benefit from very low bond yields.

UBS remains underweight on mining, AREITs and consumer staples, neutral on energy stocks and overweight on banks. The broker continues to hold selective exposure to both US dollar earners and domestic cyclicals.

General Insurance

Bell Potter believes the general insurance sector is fundamentally sound and favours the sector over the banks for the next 6-12 months, based on fewer operational distractions and regulatory constraints.

The broker believes the environment for general insurers has significantly improved in the last two quarters, as they begin to increase rates to offset claims inflation. In terms of margins, the downward trend in the banking sector could still eventuate, the broker maintains. In contrast, insurer underwriting and insurance margins have been trending higher since 2012.

Increasing loss buffers are also in stark contrast to the banks' decreasing provisions. Moreover, the compulsory nature of the industry and lower sensitivity to GDP swings suggests to Bell Potter the sector is more able to withstand any future global crises, including fall-out from a potential exit of Britain from the EU.

Breville Group

The share price of Breville Group ((BRG)) has eased off recent highs and Bell Potter considers it timely to review the company's strategy. The broker reduces inventory/sales assumptions and strengthens medium to long-term growth estimates. The net effect is a 1% increase to FY18 estimates and the target rises to $8.25 from $7.70. A Buy rating is retained.

The broker considers a more efficient inventory position should serve as a leading indicator and first signs this is happening are expected in the first half of FY17. Ultimately, the broker expects earnings growth will accelerate as the company concludes its transition into a global, innovation-driven business. Other prongs in the company's strategy include selling more effectively in existing geographies as well as obtaining control of the global product flow from manufacture to purchase.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Patience Required On Steadfast

-Benefits forthcoming in FY17
-Minimal organic growth
-Cost of strategy unclear


By Eva Brocklehurst

Steadfast Group ((SDF)) has outlined initiatives to simplify the complicated web of technology that currrently exists across its network of insurance brokers, implementing and internalising a number of new systems. The investor briefing highlighted the company's investment in its own IT systems and the deployment of new underwriting programs.

Macquarie suggests data capture, analysis and efficient delivery are at the core of the platform advantages. Management commentary also suggested Virtual Underwriter (SVU) was gaining traction across the network and its appeal should be fostered as more underwriters join. The Insight broking platform was introduced this year, with over 170 brokers looking to deploy the software. Macquarie expects FY17 to reflect the benefits of these systems, flowing into FY18.

The company's agency business has grown via acquisition significantly, to be now over $760m in gross written premium. Yet the broker notes June is a critical month for renewals and the company's commentary signals the market in key lines is flat.

Macquarie retains a positive view on the insurance broking sector and an Outperform rating on the stock. But Steadfast is now trading at a premium to the market and Austbrokers ((AUB)), so the broker envisages limited scope for further re-rating in the near term.

Credit Suisse concurs that the earnings growth potential is underscored by the technology strategy and underwriting agencies, and also that the re-affirmation of FY16 guidance signals the ongoing difficulty of achieving more than minimal organic growth. The broker expects FY17 to be another challenging year, with upside to come in outer years.

Credit Suisse would be more comfortable if the company's confidence in its systems was backed by revenue and cost targets but these were not provided. Still, the broker acknowledges the upside opportunity, should the company's strategy go to plan. In the meantime, with near-term earnings challenging, growth is being paid for in the present. Neutral rating retained.

The broker assumes there will be an increase in the cost base in the near term, likely capitalised over time to avoid profit volatility. Moreover, despite increased efficiency and availability of brokers, minimal GWP is going through the system. Not all insurers are on the system and it may be some time before this is the case. This is when the opportunity becomes real, in the broker's view.

Ord Minnett is less concerned about the present and expects that the upside will eventually come from growth and efficiencies. The company does not charge directly for its proprietary SVU platform but is encouraging the the use of Insight as a back office management tool, for which it will charge on a cost recovery basis, in turn enhancing the take up of SVU. Ord Minnett observes this will have little direct impact on revenue but should increase the efficiency of member brokers.

The main concern for the broker is that, having taken development costs at the head office, the company is not apparently prioritising equity brokers ahead of network brokers.  Moreover, the broker considers any aggregator-type competition could be detrimental to the market.

On this subject, Credit Suisse observes the Virtual Underwriter is expected to provide more functionality for brokers and the company stresses its system is not a simple aggregator model, where the lowest price wins. The broker appreciates the difference but also understands why this could be of concern among key players in the system.

Ord Minnett remains bullish on a medium term view and retains a Buy rating. FNArena's database has two Buy ratings and one Hold. The consensus target is $2.05, suggesting 1.5% upside to the last share price. Targets range from $1.70 (Credit Suisse) to $2.35 (Ord Minnett).

Steadfast recently acquired two large underwriting agencies and is expanding the capacity of its Super Binder. There are 16 binders across 30 syndicates, utilising four brokers, and the company hopes to consolidate this into one binder, co-brokered with two brokers and only six syndicates, which can write all lines of business.

The company acquired QBE Insurance's ((QBE)) Australasian agency businesses in 2015, two of which were highlighted during the investor briefing. These are Underwriting Agencies of Australia and CHU Underwriting Agencies.

The former specialises in insurance cover for industrial and commercial plant equipment and operates in Australasia and Singapore, with aspirations to expand further in Asia. CHU is the largest residential and commercial strata insurance specialist in Australia, with its products fully underwritten by QBE.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Are Health Insurance Margins Sustainable?

-Claims inflation likely heading higher
-NHF management upbeat about reviews
-MS downgrades Medibank Private


By Eva Brocklehurst

Health insurer margins are in the spotlight. Brokers interpret commentary from nib Holdings ((NHF)) as either a glass half full or empty, in terms of the outlook. The company's update clarified underlying operating profit in FY16 should be in the previously expected range of $125-135m, but comments regarding claims inflation were somewhat open to interpretation.

The trend of falling claims utilisation, which has been of benefit to private health insurers, seems to be stabililsing and potentially reversing. How slow or fast this occurs is the main issue for the outlook for FY17.

Macquarie notes the company observes claims inflation is heading back towards more normal levels post the March quarter and not declining as it was earlier in the year. That is, management is not witnessing the declines that were evident over the past 12 months. The broker finds these comments consistent with private hospital admission volumes, which are up 3.2% in a rolling 12-months to April but are tracking well below long-term averages.

Meanwhile, nib is intent on improving customer experience in terms of lapse and retention, claims management and working with the government on sector reform. The broker also observes the company expects to renegotiate debt facilities in 2016, with capital management centre stage in its considerations.

Ord Minnett remains bullish on the near term trends for nib, particularly Australian margins into FY17. The broker retains a Buy rating on the stock, the only top rating in FNArena's database with six others sustaining Hold ratings. The broker notes the CEO's remark that margins could overshoot in the near term if claims inflation remains low but that longer term nib would aim to get margins in a 5-6% range.

Yet, Ord Minnett finds no evidence from the company's comments that the favourable claims trends have started to reverse significantly, also flagging the comment that some of the claims savings from prosthetics reforms have not yet been announced, although the extent of these may be lower than expected.

The prevailing low claims inflation provides comfort to the broker that margins are likely to be strong in FY17, perhaps stronger than FY16 and some of this upside could subsequently be returned to policy holders in the form of lower premium rate increases.

Morgans notes management is upbeat about the potential outcomes of the current private health insurance review, believing disparities in prosthesis pricing will be removed. This ultimately costs the industry $800m per year.

The broker observes, in terms of the Australian Resident Health Insurance (ARHI) business, the under 40s segment is shrinking and most growth is now in the over 55s market on which nib is increasingly focused. Morgans points out that the nib lapses in membership remain higher than the market, potentially driven by a higher exposure to a younger segment, but product downgrading is a smaller issue for nib than for the broader industry.

Any benefits from elevated net margins into FY17 will be short-lived and recycled into lower prices and growth, Deutsche Bank suggests. The broker envisages some normalisation of the claims inflation trends, with future earnings growth increasingly reliant on indirect volume growth from ARHI and targeted returns in adjacent businesses.

Management expects to put through price increases to offset the 5-6% per annum industry cost growth going forward. In New Zealand, digitisation is expected to drive cost efficiencies and lift net margins to 7-8% with the company expecting a 15% return on equity in that segment by 2018. For the World Nomads business, the broker observes volume growth has slowed along with consumer sentiment and hitting targets may take longer.

Credit Suisse is a little sceptical, noting that, while management appears confident of ongoing premium rate increases around 5%, claims inflation is below historical levels and the decline appears to have levelled off. The broker also asserts management does not envisage a risk from increased pricing scrutiny and believes returns and the level of excess capital in the industry is irrelevant in respect of how much it charges the consumer.

Credit Suisse also maintains the concept of managed care in the home, cited as an opportunity by management, is uncertain in terms of expanding the earnings base, as it requires major structural change in the GP environment.

Morgans likes the overall story on nib, believing it offers a differentiated growth outlook to peer, Medibank Private ((MPL)) but considers the stock fair value. Some caution is also warranted, the broker asserts, given the ongoing government reviews.

Meanwhile, another concern for the industry has arisen in that the Australian Competition and Consumer Commission has started proceedings against Medibank Private in the Federal Court for misleading and unconscionable conduct, asserting the insurer failed to give notice to members about its decision to limit benefits paid for in-hospital pathology and radiology. Medibank Private is rejecting the claims.

Coincidentally, on the subject of Medibank Private, Morgan Stanley has downgraded the stock to Underweight from Equal-weight, believing the near-term upside is priced in and reflecting the expectations of another upgrade following a benign March quarter in claims experience.

The market seems comfortable that the company's current net margins over 8% can be sustained, but the broker suspects these will peak in FY16/17, reverting to more sustainable levels with top line headwinds and normalising claims inflation.

The broker expects a major shift to lower premium policies and lower premium rate risks will reduce top line growth at Medibank Private. Morgan Stanley agrees the limited political appetite in the current federal election year means the chance of reform is all but gone this year, although industry feedback suggests a 5-10% cut in prostheses may eventuate this year. The broker's bear case probability on this risk is unwound to 20% from 30%.

Credit Suisse considers the industry to be structurally unsustainable, but a lack of regulatory change is allowing a period of inflated earnings for nib. The broker concludes that a regulated industry cannot be faulted for an increase in costs resulting in higher profits and lower costs meaning even higher profits, but struggles to accept this environment will continue forever.

Hence, valuation remains a hurdle. In the near term the stock remains a safe investment heading into the August results and Credit Suisse retains a Neutral rating. The consensus target for NHF on FNArena's database is $4.13, suggesting 3.5% in downside to the last share price. Targets range from $3.30 (Morgan Stanley) to $4.60 (Ord Minnett).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

EclipX Confident Of Technology Advantage

-Strong growth in consumer segment
-Major synergy gains with Right2Drive
-Flexible funding advantage


By Eva Brocklehurst

Leasing and vehicle finance business EclipX ((ECX)) has provided greater understanding of its strategy at its inaugural investor briefing, highlighting its technology, integrated systems and risk management.

Credit Suisse left the briefing with further confidence in business momentum, noting management's optimism. New business is being written and while it can be hard for an outsider to dfferentiate the telematics offering from those of competitors, factors such as consistent tax rulings, integrated calendars and the ability to enable savings for clients are all crucial positives, the broker contends.

Furthermore, telematics is expected to support trends for increased fleet management outsourcing and the ability to use multiple distribution channels and leverage wholesale relationships. The stock's relative premium versus the ASX Small Industrials index that the broker suggests with its $4.10 target is considered warranted, given the strong momentum in the stock.

Citi, on the other hand, finds the stock fairly valued. Hence a downgrade to a Neutral rating. This broker is nevertheless also more confident in the ability to grow the core fleet business above system after the briefing. On the same theme Citi notes the differentiated technology, which has led to winning over clients such as Coca-Cola and Parks Victoria. Strategic diversification is also hailed a winner, with the expansion to consumer offerings such as Right2Drive from just corporate leasing.

Macquarie retains an Outperform rating despite the bounce in the stock since the May results, given the potential for the consumer and Right2Drive business. The broker observes Right2Drive is experiencing strong growth in both volume and revenue and should be able to grow even faster with the backing of EclipX.

Leasing costs are a major synergy gain, as Right2Drive will now be able to source cars internally, and this is a key input into a forecast uplift in margins in FY17. There are 1,200 cars available for hire and this supports the broker’s FY17 revenue estimates. The company is also preparing new warehousing to become more cost competitive in the government and large corporate market.

Presentations by division managers and outlining of specific business initiatives underscore Deutsche Bank's conviction in the stock. A turnaround has been navigated and the broker expects the company to now capitalise on its scale, efficiency and capabilities. Initiatives such as telematics, straight-through processing, fleet analytics and customer portals are proving to differentiate the company in the market, evidenced by strong growth in new business.

Deutsche Bank expects this technological advantage will deliver cost and margin enhancement over several years. The broker also envisages a strong opportunity to grow share in the consumer segment through new distribution channels and cross selling, supported by the recent acquisition of Right2Drive.

What is Right2Drive? This is a medium-term rental operator and customer of EclipX. The business provides rental replacement vehicles to eligible drivers who have damaged cars in an accident. Right2Drive has 16 branches across Australasia and is the largest domestic player, with a 7.5% market share.

UBS observes the accident vehicle replacement market in Australia is small and under developed, with low levels of awareness at both a consumer and corporate level. This provides scope to lift the profile of the business.

EclipX also has a flexible funding system which allows intra-lease adjustments, a significant advantage in managing risk Deutsche Bank maintains. Several additional distribution channels have been developed for end-of-lease assets, which the broker believes provide an advantage in pricing.

On FNArena's database there are five Buy ratings and one Hold (Citi). The consensus target is $3.87, suggesting 4.5% in upside to the last share price. Targets range from $3.42 (Morgan Stanley) to $4.20 (Macquarie).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.