Tag Archives: Property and Infrastructure

article 3 months old

Weekly Broker Wrap: Strategy, Infrastructure, Wagering And Receivables

Unforgiving market continues; infrastructure sells off; flat outlook for construction; Canaccord Genuity covers receivables; Bell Potter initiates on TPI Enterprises.

-Stocks with valuation appeal and upgraded earnings likely to be the "new" defensive stocks: Macquarie
-Greatest downside risk to expectations in staples, A-REITs and industrials: Ord Minnett
-Infrastructure cash flow up but sector sells off on spectre of rising rates
-Banks can probably achieve strong CET1 ratios organically


By Eva Brocklehurst

Equity Strategy

Macquarie expects commodity, capital expenditure and consumer related stocks will be dominate themes through the next up-cycle but to achieve greater certainty on the trend requires more indication of where rates and the US dollar are going. Until more durable themes emerge, the broker expects the market to remain unforgiving, with much of the market upside in recent years driven by a bull market in defensive stocks.

Macquarie contends that disappointment over earnings is generally the death of high multiple growth stocks such as Aconex ((ACX)), CSL ((CSL)) and TPG Telecom ((TPM)) and bond yields are the death of high multiple dividend yield stocks such as Charter Hall Retail ((CQR)), GPT Group ((GPT)) and Scentre Group ((SCG)).

It will be stocks for which valuation appeal and/or earnings are being upgraded that will act defensively along with higher interest rates. Macquarie is looking for stocks where upgrades are accompanied by a low analyst forecast spread such as BHP Billiton ((BHP)), BlueScope ((BSL)), Downer EDI ((DOW)), Fortescue Metals ((FMG)), JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)).

In the current environment the broker believes a bigger discount is needed for long duration stocks such as Macquarie Atlas ((MQA)), Sydney Airport ((SYD)) and Transurban ((TCL)). Among stocks which have suffered downgrades but greater price declines the broker likes Commonwealth Bank ((CBA)) and Telstra ((TLS)).

Ord Minnett concludes from its analysis that downside risk to consensus earnings per share (EPS) forecasts has increased and capital management prospects are diminished. Market expectations have, nonetheless, picked up thus far in September and the broker notes the materials sector is supporting a large proportion of the upgrade. Staples, A-REITs and industrial sectors are the areas in which Ord Minnett envisages greatest downside risk to consensus expectations.

Following a protracted period of elevated capital management, the broker envisages a deceleration in activity, particularly for consumer discretionary, energy and health care sectors. Ord Minnett retains a positive view across the China/steel/iron ore complex but remains modestly concerned about earnings being flat in energy and the risks of increased supply from Nigeria and Libya.


Lower interest costs have boosted cash flow for infrastructure companies but Deutsche Bank observes the sector has now sold off amid expectations interest rates globally will start edging higher. The broker acknowledges the companies will argue that cash flows will not be affected by rising interest rates until a majority of debt is refinanced but believes some of the terms and conditions may change.

Deutsche Bank calculates that much of the current available cash flow would need to be re-directed to pay back outstanding debt and this ranges from 15-49% of the current cash flow currently going to shareholders. The broker is not yet convinced rates will rise but, once they do, there is likely to be more than one rise to normalise settings. Moreover, the broker is not convinced rising rates will accompany materially improved growth and believes this is a reason the sector has sold off so sharply on just the spectre of rising rates.


UBS expects FY16/17 will be the bottom for total construction and the outlook is near flat. While construction is unlikely to return to the pre-GFC boom years the environment is still considered to be better than witnessed in recent times. The broker expects mining construction will remain in a slump out to FY18/19 and the drag will diminish as the segment becomes smaller. Housing is expected to flatten and turn down sharply in FY18/19.

The gaps may be filled if UBS is underestimating the structural support in the economy from ultra-low rates and foreign demand. Moreover, public construction is expected to provide a solid, if only partial, offset. Hence, the necessary filler will be the long-awaited recovery in non-mining business investment, the broker expects.


Deutsche Bank estimates that the Basel IV reforms will entail a 50 basis points impact on major bank pro-forma CET1 (common equity tier one) ratios and this fits with the capital build-up required to push the majors further into the top quartile of global ratios. The broker expects the impact can be offset by organic capital generation rather than on-market capital raising. This would also address APRA's call for the majors to be unquestionably strong on capital.

Deutsche Bank believes 50 basis points increases from an average second half of FY16 pro-forma CET1 ratio of 9.3% could be achieved organically over FY17-19 with only National Australia Bank ((NAB)) having to rely on discounted dividend reinvestment programs. This would be consistent with forecasts for CET1 ratios of almost 10% by FY19. Such an outcome could lend share price support to the sector.

The broker's top picks remain Westpac ((WBC)) and National Australia Bank.


Wagering revenue growth slowed to 5.7% in the second half of FY16, partly related to luck, with turnover up 16.9%. UBS notes growth continues to be driven by new entrants in the market as well as elevated levels of promotional activity from corporate bookmakers. UBS observes the shift in consumer preferences continues to evolve with digital betting taking a higher market share.

While this is outside of the control of Tabcorp ((TAH)) and Tatts ((TTS)) the broker still expects Tabcorp can deliver 2-3% revenue growth while Tatts is affected by a significant migration of tote to fixed odds betting that is causing structural pressure in terms of yield, ie a company-specific issue. Wagering for Tatts is expected to endure declining EBIT (earnings before interest and tax) over the next two years.


Canaccord Genuity estimates the investable market for debt ledgers in Australia is around $440m and around 80% of this will originate with the four major banks, GE Money and Telstra. As a result, unsecured personal loan and credit card balances represent the overwhelming majority of debt purchased in Australia in FY17.

The broker notes Credit Corp ((CCP)) is the largest purchaser of debt ledgers and has been able to expand its annual purchases consistently while maintaining the quality of its balance sheet. A Buy rating and $19.42 target kicks of the coverage of the stock.

Collection House ((CLH)) is likely to be the third largest purchaser this year. The company downgraded in FY16 and a reduction in purchasing activity was noted for the second year running. Management changes provide the opportunity to re-position the business, Canaccord Genuity believes and may also mean some near-term write downs. The broker initiates with a Sell rating and $1.06 target.

Pioneer Credit ((PNC)) listed on ASX in 2014 and is in the early stages of growth with a significant increase in ledger investments, which the broker observes have only just begun to be outpaced by annual cash collections. Canaccord Genuity initiates with a Hold rating and $1.85 target.

TPI Enterprises

TPI Enterprises ((TPE)) combines long-term growth outlook in healthcare with the volatility inherent in the agricultural sector and Bell Potter initiates coverage with a Speculative Hold rating and valuation of $3.17.

The exposure to agriculture relates to poppy growing in Australia, where local growers producer around 45% of the raw materials for narcotic production globally. Until recently this industry was confined to Tasmania. The company has now relocated to the mainland and the broker expects this move may increase the number of growers and result in a far more competitive environment, boding well for the TPI.

The Melbourne production facility is the first commercial scale, solvent free extraction plant in the world and, relative to other producers, its cost of production should be significantly cheaper at scale, Bell Potter contends, proving a sustainable cost advantage.

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article 3 months old

Favourable Yield Sparks Interest In Propertylink

Propertylink, a manager of industrial assets, has piqued the interest of several brokers since listing, given the opportunities offered and a favourable distribution yield.

-Aims to leverage asset management capability and take advantage of potential in B-grade commercial assets
-Execution risks around leasing and funds under management considered priced in
-Current price provides attractive entry point in Goldman Sachs' view

By Eva Brocklehurst

Propertylink ((PLG)) has piqued the interest of several brokers since its recent listing on ASX, given the stock offers an attractive prospective distribution yield and appears to be fully pricing known risks.

The Australian real estate investment trust (A-REIT) is internally managed and has an independently valued $685m portfolio of 33 assets, predominantly B-grade industrial space in Sydney and Melbourne. Portfolio occupancy is 95%, excluding assets held for sale or undergoing redevelopment. There is also a funds management (FUM) platform at around $1bn which is backed by eight global institutional investors.

The company's aim is to leverage its asset management capability and take advantage of secondary grade commercial assets that have the potential to add value. Propertylink manages assets and funds on behalf of A-REITs, pension funds, insurance companies, as well as investment advisors. These investment partners are located across the globe and the group has been successful at introducing new capital partners and growing funds and assets under management (AUM).

Credit Suisse has initiated coverage with an Outperform rating and 92c target, noting the stock offers a prospective distribution yield of 9.1%. The comparison with a sub-set of A-REITs based on similar portfolios is favourable. The broker's selected peer group trades at a free funds from operations (FFO) average yield of 8.0% which compares with Propertylink's prospective FFO of 9.6%.

At current levels the stock is implying a 7% discount to current book values versus the 6% average premium implied for A-REITs so Credit Suisse believes execution risks around leasing and FUM are more than priced in. The broker acknowledges that estimating an implied multiple for the FUM of any A-REIT entails a high degree of subjectivity.

Charter Hall ((CHC)) and Goodman Group ((GMG)) offer the clearest comparables to Propertylink's fund and asset management business. It could be argued, Credit Suisse contends, that the size and established nature of these two means Propertylink warrants either a discount – being less established – or a premium – given greater growth potential.

In sum, the broker considers the stock a unique opportunity given the experienced management team and a fully integrated platform along with a sound balance sheet. This means the business is well positioned to cope with the relatively high level of risk when it comes to income expiry in the medium term. The weighted average lease expiry was 3.6 years as of June 30 2016.

Goldman Sachs agrees the stock is a source of opportunity and has a Buy rating. The broker's $1.00 price target implies a forward distribution yield of 8.7%, the highest in its A-REIT coverage. The stock is down around 16% since its listing on August 5, providing an attractive entry point in the broker's view.

Goldman also believes concerns about current and future leasing risk within the portfolio are priced in. The outlook contains the potential to close the valuation gap via additional third-party capital and enhance earnings growth. Successful leasing outcomes on existing vacancies should also support earnings.

Ord Minnett initiates coverage with an Accumulate recommendation and 95c target price, noting Propertylink's pro forma distribution yield is nearly double the sector average of 4.7%. Income is sustained from its portfolio of assets, and growth is expected to be driven by FUM. The broker likes the team's approach to taking advantage of re-positioning opportunities and managing its lease expiry profile.

The FUM business represents around 12% of earnings and Ord Minnett expects revenue growth in this segment at around 10% per annum over FY17–21, excluding potential performance fees. The broker believes the focus is on two fronts, managing the expiry profile, as 47% of the portfolio expires in the next three years, and raising and investing capital to grow the funds business.

In FY17, Propertylink intends to lift occupancy to 96% and grow external AUM by $750 million to $1.5 billion. Ord Minnett notes it has already acquired $310 million of this target and has a further $290 million in advanced discussions. Within leasing, Propertylink has agreed terms on 11 of its 27 expiries in FY17, with the broker observing good progress made on a number of the remainder.

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article 3 months old

Weekly Broker Wrap: Earnings, Apartments, Consumer, Wellard And Telstra

Earnings season wrap up; apartment approvals spike; consumer spending growth; harsh outlook for Wellard; Telstra's dividend dilemma.

-Ord Minnett scales back financials and health care, increasingly favours metals & mining
-UBS suspects market vulnerable to a set back but any correction likely to be shallow
-Developing oversupply of apartments to gain momentum in 2017 and 2018
-Weaker wealth trend seen reducing spending growth in 2017
-Wellard in breach of facilities and may be forced to sell assets
-Does Telstra need to change its dividend policy?


By Eva Brocklehurst

Reporting Season Wrap

Ord Minnett is disappointed with reporting season. FY17 earnings projections have slipped by 1.3%, and only 24% of the S&P/ASX 200 index beat expectations for FY16. The broker has scaled back its position in financials and health care, after the two sectors fell 2.5% and 3.7% respectively in the month.

In contrast, Ord Minnett observes the metals & mining sector is increasingly favourable and moves its weighting to Neutral. The broker is also encouraged by the positive aspects of the consumer discretionary sector and reinstates it to Overweight.

The broker contends that two stalwarts of the yield play have languished, with telecommunications edging out insurance to claim the wooden spoon. Ord Minnett observes the slide in utilities in the month also looks to be underpinned by fundamentals with AGL Energy ((AGL)) exerting the most drag, and its FY17 earnings estimates scaled back 3.5%.

Meanwhile, energy was resilient, up 2.8%, and materials and staples were up 1.9% and 2.6% respectively in the month. The broker shifts its materials weighting to Neutral and remains Underweight on staples.

UBS suspects a degree of complacency has crept back into the investment landscape and the market could be vulnerable to a setback. Nevertheless, recession risks for the US and Australia are low, in the broker's opinion. Hence any correction may again be shallow and present a buying opportunity.

The broker remains cautious, but not outright bearish, about the market and continues to believe stocks offer better prospects than bonds and cash on a 6-12 month view. UBS is, on balance, underweight on the defensive yield trade, envisaging it is overvalued versus other parts of the equity market.

The broker considers the market is likely under-pricing a tightening from the US Federal Reserve. Still, the Fed remains constrained by a lacklustre global economy and any bond yield back up is expected to be moderate.

Australian Apartments

Building approvals sustained the largest monthly rise in 2.5 years in July, Citi notes, and the gain was led by NSW, followed by Western Australian and then Queensland. The broker also observes the rise was completely driven by a large spike in apartments, extending the trend in the medium and high density segment of the market. It also underlines the emerging trend of softly falling owner-occupier approvals on the headline result.

Citi suspects the risk that a number of approvals do not turn into dwelling starts is growing. Apartment completions lag starts by 1-2 years so the developing oversupply should continue to build in 2017 and 2018, with the broker estimating completions will probably double across the eastern states.

Relative to underlying demand, Brisbane is considered oversupplied as is inner Melbourne. Sydney is still catching up and the broker can only suspect that the underlying demand in Sydney is able to absorb such a large impact from building approvals in the supply chain.

Citi does not envisage conditions are sufficient for contagion from projected apartment price declines in some areas to spill into broader house price declines.

Wealth And Consumer Spending

UBS argues that the pick-up in consumer spending since 2013 is sustainable and, so far, solid jobs growth and better consumer cash flow from low inflation have driven stronger real spending, despite low wages growth.

UBS updates its model to calculate how a flatter outlook for housing & equity prices, and record low wages growth, weighs on the consumer, despite recent reductions to interest rates. The lagged impacts of this weaker wealth trend is conspiring to drag spending growth lower in 2017, in the broker's opinion.

Hence, UBS trims consumer growth forecasts to 2.5% from 2.8% for 2017, with 2016 little changed at 2.9% from 3.0%. For retail sales, a near-term boost to household cash flow from lower petrol prices, tax and rate cuts should mean a return to the growth range of 4-5% from the current level under 3%.


Deutsche Bank downgrades Wellard ((WLD)) to Hold from Buy in the wake of the FY16 results, which signalled the company is in breach of its working capital facility and may be in breach of certain financial covenants. The broker reduces the target to 30c from 75c. Deutsche Bank observes that earnings have been affected by the inability to pass through the historically high cattle prices to traditional customers in Indonesia and Vietnam.

Morgans observes, should Wellard be unable to renegotiate its loan facilities, the business will not continue as a going concern and it may be forced to sell assets. Given conditions have deteriorated further in FY17, the broker has little confidence in forecasts. Morgans maintains a Reduce rating and considers the stock a high-risk investment. Target is 25c.


Credit Suisse believes Telstra ((TLS)) has an emerging dilemma over its dividend. The earnings gap as NBN payments roll off is rapidly approaching and will result in core recurring earnings per share (EPS) falling significantly over the next 2-3 years. This core EPS is forecast to fall as low as 23.2c per share in FY19.

Credit Suisse maintains that if Telstra sticks with its current dividend policy, the dividend would likely need to be cut in the outer years. If Telstra changes its policy and pays a dividend above EPS for a period, earnings from areas such as mobile and network access could have time to catch up with the pay-out, the broker contends.

There is no near-term dividend risk, as NBN payments should support cash flow and reported earnings, but Credit Suisse envisages dividend sustainability will start to worry investors in the medium term. Moreover, history shows that Telstra's yield tends to rise, ie the share price declines, when there is concern about the long-term sustainability of its dividend.

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article 3 months old

Watch Lend Lease

By Michael Gable 

Apart from the RBA minutes today, this week is all about company results as we head into the busiest time for this reporting season. In today's report we have had a look at Lend Lease ((LLC)).


For the last few months, LLC has hit a bit of a ceiling around this $13.60 level. What we like about the recent price action though is the fact that it has consolidated just under it during the last couple of weeks. A stock that consolidates under a high is a positive sign because it is essentially readying itself to burst above it. LLC reports on Friday so that should be the catalyst that we need. If LLC does go through this current resistance level, it could spike towards $14.50 before settling back down. But ultimately, a break of that mid $14 region could see it make the next leg up towards $16.

Content included in this article is not by association the view of FNArena (see our disclaimer).
Michael Gable is managing Director of  Fairmont Equities (www.fairmontequities.com)

Michael assists investors to achieve their goals by providing advice ranging from short term trading to longer term portfolio management, deals in all ASX listed securities and specialises in covered call writing to help long term investors protect their share portfolios and generate additional income.

Michael is RG146 Accredited and holds the following formal qualifications:

• Bachelor of Engineering, Hons. (University of Sydney) 
• Bachelor of Commerce (University of Sydney) 
• Diploma of Mortgage Lending (Finsia) 
• Diploma of Financial Services [Financial Planning] (Finsia) 
• Completion of ASX Accredited Derivatives Adviser Levels 1 & 2


Michael Gable is an Authorised Representative (No. 376892) and Fairmont Equities Pty Ltd is a Corporate Authorised Representative (No. 444397) of Novus Capital Limited (AFS Licence No. 238168). The information contained in this report is general information only and is copy write to Fairmont Equities. Fairmont Equities reserves all intellectual property rights. This report should not be interpreted as one that provides personal financial or investment advice. Any examples presented are for illustration purposes only. Past performance is not a reliable indicator of future performance. No person, persons or organisation should invest monies or take action on the reliance of the material contained in this report, but instead should satisfy themselves independently (whether by expert advice or others) of the appropriateness of any such action. Fairmont Equities, it directors and/or officers accept no responsibility for the accuracy, completeness or timeliness of the information contained in the report.

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article 3 months old

As Good As It Gets For Goodman?

Leading A-REIT Goodman Group has posted yet another solid result, shining among peers. But how long can the tailwinds last?

- Another year of guidance-beating earnings
- Plenty of cash to deploy
- Signs of margins easing
- Signs of growth rate abating

By Greg Peel

There was no surprise among analysts of Australian real estate investment trusts (REIT) when Goodman Group ((GMG)) announced FY16 earnings growth of 7.8%. Management most recently upgraded guidance to 7.5% growth, but as Macquarie points out, the trust has begun each of the last three years with guidance of 6% growth and delivered 7.4%, 6.9% and 7.8% respectively.

For FY17, Goodman has guided to 6% earnings growth.

And it’s difficult to see how that will not be achieved. As Macquarie notes, property investment revenue is largely contracted, management earnings are predominantly recurring and the most unpredictable part of the business – property development – commences with $3.4bn of work in progress, underpinning at least half of development earnings required to meet the 6% earnings growth target.

Analysts like Goodman’s structural story. The REIT is focused on logistics, developing properties to support more modern and efficient distribution networks for the world’s growing focus on e-commerce. And Goodman’s developments span the globe.

Alongside $3.4bn of development work in progress is $34.1bn of assets under management and a “world-leading” funds management platform, as Morgan Stanley describes it. At 11.8%, gearing is low, and Goodman boasts $10.3bn in undrawn debt, equity and cash, with cash sitting at $1.3bn.

In this age of ultra-low global interest rates, cash generates very little return. But low interest rates also mean strong demand for yield elsewhere, and thus ever higher property prices. Goodman could decide to return cash to shareholders via some form of capital management, and many a shareholder would thus be pleased, but as Macquarie calculates, $1bn of investment in new property generating a 6% return would be around 5% earnings accretive, and gearing would still remain comfortably under 20%.

Hence there is incentive to keep plugging on. But how long can it all last?

Let’s take the analogy of Sydney-Melbourne property prices. For the past few years these have soared, prompting concerns of a housing bubble, as investors have sought yield through property when very little yield is available from other investments of similar low-end risk. While fresh APRA regulations have forced investors to back down somewhat this year, further RBA rate cuts have ensured owner-occupiers have picked up the slack and property prices just keep on rising.

For investors, yields are falling with each higher price paid, given low wages growth ensures rents are not keeping pace with property values. At some point, a line in the sand will be reached on property value, relative to supply. But economists are predicting further RBA rate cuts so the end may not be in sight just yet.

Around the globe however, how much room is there for even lower interest rates? Japan and many European countries already have negative rates, and powerhouse economies such as Germany have a near zero rate. There is a possibility US rates will begin to rise. Central banks have reached the point at which they have to tell their respective governments there’s little in the way of monetary firepower left, and it's time fiscal policy took the baton.

Therefore, how much longer can the values of Goodman-style properties keep rising? In FY16 asset values continued to rise across the globe, with the exception of a Brexit-hit UK and floundering Brazil. Cleary the structural story of e-commerce and logistics will continue to support demand, but at what point does value peak?

Just as the yield on Sydney investment property is falling as rents fail to keep pace with value, Goodman’s rental income to asset value measure is now also falling. In REIT terms this is known as capital, or “cap” rate compression. Falling cap rates are representative of rising asset values, and each time Goodman develops a property in a rising value market it delivers a margin on the cost of building.

Ord Minnett has looked at yield on costs. In FY16 this was a very healthy 21% but this has compressed from 25% and is actually the lowest it’s been since 2009. If cap rates stop compressing – property value growth slows against rent growth – Goodman’s development margins will moderate.

Goodman also takes performance fees on delivering development returns. Analysts consider this element of the trust’s earnings to be “low quality” despite the quantum of earnings performance fees are currently generating, given these will be the first to give way when the tailwinds start to ease.

UBS further points out that while significant development margins still remain, Goodman’s development work in progress declined 2% in the second half – the first fall in almost five years. Development yield has fallen to 7.8% from 8.3%. This still compares favourably to an average cap rate of 6.4%, but as UBS puts it, are development yields now “maxing out”?

Perhaps the trends are suggesting it might be time for Goodman to indeed look at rewarding shareholders with capital returns rather than pushing that little bit too far on development. But unfortunately it’s not that easy. Ahead of rewarding shareholders, Goodman has to service its debt, and clearly there is  risk in allowing debt to rise too far if indeed we are starting to see signs of an easing market, just as an overstretched mortgage is a danger in a housing bubble.

Around 85% of Goodman’s debt is in bonds and US private placements, which cannot be repaid early. Therefore, Goodman must continue to deliver earnings growth ahead of the opportunity to pay down debt, and for that it needs to deploy its cash, not give it away.

The music has not yet stopped. Indeed, analysts see no reason FY17 won’t be another year in which Goodman starts with 6% earnings growth guidance and ultimately delivers something higher. By FY18 however, well, maybe those numbers will start to pull back.

Which then brings share price into perspective. Of the six brokers in the FNArena database covering Goodman, four rate the stock a Hold or equivalent. Only two are sticking with Buy. Goldman Sachs – not a database broker – also has a Hold rating.

Macquarie is sticking with Buy (Outperform). The broker’s argument is based on the premium the market is applying to predominantly rent-collecting A-REITs. In arriving at a $7.47 target for Goodman, Macquarie is assuming an 8% premium. Were 15% assumed, that value would be $7.80. And Macquarie can’t get past Goodman’s low gearing and cash balance and the opportunity that provides for further near term earnings growth.

Morgan Stanley is also persisting with Buy (Overweight). However in the analysts’ own words:

“We walked away from the FY16 results presentation thinking that growth will become harder from here, there will be fewer catalysts or surprises to attract the marginal investor, and we expect scrutiny around the capital management strategy, growth drivers and quality of earnings (more volatility, more performance fees) to intensify. Whilst we are comfortable with our A$7.70 price target, we expect the delta [pace of growth] in NAV [net asset value] and cash flow valuations to slow down from here.”

Morgan Stanley’s opinion echoes those of brokers with Hold ratings.

The consensus price target in the FNArena database is $7.39, suggesting 0.8% downside from Friday’s closing price, in a range of $7.20 (UBS) to $7.70 (Morgan Stanley). The consensus FY17 dividend yield is 3.4%.

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article 3 months old

Further Re-Rating For Downer?

Several rail contracts are about to be awarded and success on any or all of the tenders could be a catalyst for re-rating Downer EDI, brokers note.

-Quality of DOW's FY16 result bodes well for FY17
-M&A opportunities and capital management potential
-Still facing decline in mining & construction earnings
-Expanding role in the defence supply chain

By Eva Brocklehurst

The outlook for Downer EDI ((DOW)) is firmly planted in the award of several large rail contracts, which promise to underpin a re-rating of the stock if won.  The company is a front runner on three rail contracts, likely to be awarded in the first half.

The strong second half of FY16 was supported by cash flow, which suggests to Ord Minnett the quality of the result is high and bodes well for FY17. The stock closed 8% higher after the report and the broker believes, given it is still trading at a discount to peers of 23% on FY17 multiples, there is room to run further.

Ord Minnett acknowledges a back flip in its recommendation, upgrading the stock to Buy from Lighten. The broker estimates Downer EDI could spend around $550m on acquisitions and still keep gearing below 20%.

The main risk to broker viewpoints is the fact the company is still facing a decline in mining and construction earnings, with LNG construction finishing up a year’s time. Ord Minnett forecasts earnings in FY18 to dip as well – FY17 is expected to be lower – before the company starts to grow again. With a declining earnings profile investors are not expected to rush back into the stock but the broker asserts the multiples appear too low, relative to peers.

Credit Suisse concurs, expecting further diversification should drive a re-rating of the stock. Yet, while envisaging value in the medium term, the broker suspects investors may prefer to wait for a bottoming of contract mining earnings before appropriately recognising the value.

Over 55% of the company’s revenue is generated from servicing public infrastructure in Australia and New Zealand. This percentage is expected to increase as the business emphasis moves to transport, utilities and communications and away from mining. Credit Suisse also suggest recurring public infrastructure and maintenance work should warrant a higher multiple.

The broker believes FY16 results suggest the bear case scenario is unlikely to materialise and, besides contract mining, all divisions should deliver a modest improvement in FY17. The broker expects tight cost controls and strong operating cash flow will allow the balance sheet to return to a net cash position over the next 12 months. This will provide the opportunity for capital management and/or mergers & acquisitions, both potential catalysts.

The company is still not in the clear, Morgan Stanley contends. Mining and engineering represented around 48% of earnings in FY16 and the broker expects this segment to continue to pressure the earnings profile. Earnings from Fortescue Metals ((FMG)) will cease from September this year and margin pressure in contract mining is expected to increase. Work on Gorgon rolls off in FY18 and Wheatstone finishes in FY18-19.

The broker also maintains that should Downer fail to win the three rail projects, it could result in $25m in bid costs being expensed in FY17. Still, the outlook is better than Morgan Stanley previously perceived and the margin continues to surprise modestly to the upside. The broker’s base case is for a flat earnings outlook through to FY19 but the next six months is expected to be the litmus test for earnings, given the bidding profile.

The results confirmed for Macquarie that the company is the best in its sector. The guidance suggests the transition from resources to more infrastructure and services is bottoming out. For this to convert to growth now depends on the outcomes of the rail contracts.

The broker believes Downer EDI is best placed on the Sydney rail contracts, with $2bn in NSW InterCity contract awards expected in the September quarter and the $1bn suburban rail passenger contract to be known in November. The $3bn Victorian rail contract outcome is also expected this month.

Macquarie also notes Downer is seeking to expand its role in the defence supply chain and the company is one of the few Australian owned ASX100 engineering services which can play a significant role in delivering the investment in facilities planned by the Australian government.

Deutsche Bank likes the management team, the diversity of earnings, high cash conversion and strong balance sheet. While there are challenges in the resources sector the broker envisages growth opportunities in renewables, telecommunications and utilities.

Citi, too, is of the view that the exposure to public infrastructure investment means that the company is in a robust position in the medium term, notwithstanding the risks in the rail contracts and the large oil & gas projects. The broker contends the 20% jump in the share since late June has anticipated this outlook to some extent but the stock remains one of the best placed options in the sector.

FNArena’s database shows four Buy ratings and two Hold. The consensus target is $4.67, suggesting 0.6% upside to the last share price. This compares with $3.66 ahead of the results. The dividend yield on FY17 and FY18 forecasts is 5.1% and 5.0% respectively.

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article 3 months old

Where Best To Find Yield

-Office stands out among A-REITs
-Are A-REITs becoming expensive?
-Stable cash flow supporting utilities
-Infrastructure retains high IRR


By Eva Brocklehurst

Ahead of the August results brokers are reviewing the returns for various sectors which are described as yield performers in the face of a weak economic outlook, low bond rates and low inflation.

UBS calculates that in both US dollar terms and local currency, A-REITs have been the best performers in the year to date. The broker is overweight Australian Real Estate Investment Trusts (A-REITs) and believes the sector's FY16 dividend yield of 4.2%, or 4.5% excluding Westfield ((WFD)), is sustainable, based on an 85% earnings pay-out. Retail and office A-REITs are considered well positioned to deliver modest rental growth over the next 12 months.

The Sydney office cycle is being underwritten by withdrawals and low supply, UBS contends, and vacancies are expected to trend below 5% by the end of 2018. With vacancies below 5% rental growth is expected to be 5-15%. On the other hand, vacancies are increasing nationally, the broker acknowledges, underpinned by Brisbane and Perth, and forecast to hit 11.6% by December.

Tightening yields have induced a supply response in the Sydney CBD office market, Credit Suisse notes. Analysis suggests developers can build for $16,000/sqm compared with prevailing values of around $22,000/sqm. This suggests the potential to undercut landlords via pre-commitment deals on lower effective rents.

The view is underscored by recent planning strategies in Sydney's CBD that have shifted heavily in favour of commercial development over residential. Limited medium-term supply is generating interest in the rental growth prospects, but Credit Suisse questions the sustainability of the prospects. Rentals are being inflated by incentives, the broker suspects, providing benefits to developers.

The broker's order of preference among office A-REITs is based on relative value and sustainable risk-adjusted medium-term growth, with particular regard for distribution growth underpinned by operating cash flow.

Mirvac Group ((MGR)) is the top preference, given the attractive asset quality, geographical mix, recurring income security and strong relative growth, but the broker recently downgraded to Neutral from Outperform, given the stock has run through its upgraded target price of $2.15. Investa Office ((IOF)) is also considered to have substantial leverage to upside in the medium-term Sydney office segment. The best performing CBD A & B grade segments account for 52% of the stock's total asset base compared with 17% on average for its peers.

Morgan Stanley expects the results season will reveal improving net operating income for office A-REITs and improved settlement and earnings certainty to those exposed to residential markets. The broker envisages a tactical opportunity in Mirvac, Stockland ((SGP)) and Lend Lease ((LLC)) heading into the results.

Morgan Stanley considers its 4.6% one-year distribution yield and 3.9% free funds from operations growth estimates for the sector are defensive. Yet, after outperforming in the year to date circa 15%, A-REITs are becoming increasingly expensive versus other yield sectors, the broker maintains.

The flattening in the slope of the yield curve should provide further support but Morgan Stanley is increasingly concerned that the accommodative environment could mean a lack of focus by companies on sustainable growth initiatives, such as reducing costs and cleaning up portfolios, in favour of acquisition-led accretion.

Goodman Group ((GMG)) remains one of the broker's top picks, given its diversified business model and superior growth. A guidance upgrade may be forthcoming from GPT Group ((GPT)), on a strong results from its funds management division, but with limited news on efficiencies, increasing developments and recovery in re-leasing spreads, the broker retains an Underweight rating.

Morgan Stanley envisages 10-year bond yields will fall to 1.5% by March 2017, down another 50 basis points from current levels. This should flatten the yield curve and continue to drive outperformance in the A-REIT sector. Further rotation into A-REITs could be forthcoming throughout the earnings season.

Retail A-REITs have traditionally been defensive but the broker expects the challenged outlook for the consumer will mean retailers become more selective. This is expected to drive increasingly defensive development capex and decreased rental/re-development returns, putting pressure on pay-out ratios.

Meanwhile, the improving market fundamentals of the office segment will lead to lower capex and drive an increase in sustainable distribution growth, the broker maintains. In sum, Morgan Stanley has Overweight ratings for Dexus Property ((DXS)) and Investa Office, and remains Underweight on all pure-play retail A-REITs.

Low inflation rates are negative for utilities with unregulated assets and regulated assets already into their 5-year regulatory periods, because inflation-linked revenues are lower. Nevertheless, Citi still expects that the search for yield will support the share prices of regulated utilities, given their long-term stable cash flow and distributions.

Among utilities and infrastructure funds, APA Group ((APA)) is now considered to have the most potential to materially grow distributions, but a weaker growth outlook and lower inflation, with the risk to short-term services revenue, could mean distribution growth is lower than some expect. Citi's preference is for DUET ((DUE)) followed by Spark Infrastructure ((SKI)), and then APA, followed by AusNet Services ((AST)).

Shaw & Partners also ranks three listed infrastructure stocks by their internal rates of return (IRR) and forecast distributions. The broker acknowledges the concessions vary, but believes the analysis does illustrate the opportunity, based on a belief the sector as a whole will trade on a forecast yield. The broker rates Macquarie Atlas ((MQA)) as a Buy, as it has the highest rate of return at 8.0%. Sydney Airport ((SYD)) and Transurban ((TCL)), both Hold rated, follow with 6.5% and 5.2% respectively.

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article 3 months old

Australian House Prices Set To Fall

- Investor demand for housing declining
- New dwelling completions still rising
- Market to enter oversupply


By Greg Peel

“Get set for weaker conditions across the board in residential property markets.”

So opens a press release from industry analyst and economic forecaster BIS Shrapnel on the publication of its latest report, Residential Property Prospects, 2016 to 2019.

It is well understood that in the last several years, demand for property as an investment in Australia has surged. Drivers include a low interest rate environment, providing for cheap financing, low bank deposit rates, forcing a search for alternative yield investments, and a general hangover from a GFC which scared many longer term investors away from the stock market.

Clearly another reason is “FOMO” – fear of missing out. The investment property market has witnessed a classic stampede of the herd. This is no more evident than in Sydney and Melbourne, which aside from being the country’s biggest two cities are benefitting from New South Wales and Victoria enjoying more robust economic growth than the mining states, which have been faltering.

Indeed, recent price growth has been concentrated in Sydney and Melbourne, with other capital cities showing either modest growth or declines. Investors have been elbowing out genuine owner-occupiers, while first home buyers have been left in the dust. In response to the boom in investor demand, dwelling construction has also accelerated. But whereas detached housing has always been the Australian dream, apartments have seen an unprecedented surge in construction. Apartments offer developers more profit per square metre.

In response to RBA fears of an investment housing bubble, last year APRA tightened restrictions on bank lending books, forcing up the cost of borrowing for investment. Investors were quick to respond, and demand has been easing over the course of 2016. Easing bubble fears allowed the RBA to respond to issues in the wider economy and further cut interest rates. This played into the hands of owner-occupiers, who began to find less competition for dwellings and as such, to some extent have offset the decline in investor demand.

Under normal circumstances, population growth is the underlying driver of housing demand.  In 2014-15 national population growth fell to its second lowest level since 2005-06, BIS Shrapnel notes. Overseas migration fell to 176,500 in 2014-15 from 229,400 in 2011-12. The majority of these migrants are classified as “long term overseas visitors”, suggesting they might be here for a while but will not actually stay.

Nationally, BIS Shrapnel anticipates 220,000 new dwellings will have commenced in 2015-16, translating into a peak in dwelling completions in 2016-17. Apartment blocks may be more profitable on the same footprint but they also take a lot longer to build, meaning there will be a lag of new dwelling completions into 2017-18. Underlying demand for new dwellings is expected to run at an average 159,200 over annum over the next five years. Thus as the aforementioned new dwellings move to completion, all states bar New South Wales will move into dwelling oversupply, or increase existing oversupply.

BIS Shrapnel expects all markets to steadily weaken and bottom out over 2017-18 and 2018-19, with house prices largely flat or in decline over this period. Aside from population growth, economic growth and subsequent employment growth is a major driver of housing demand. As Australia’s economy transitions away from mining investment, economic growth nationally is expected to be muted. Even in the economically stronger New South Wales and Victoria, there is limited further upside to prices, BIS Shrapnel believes.

APRA’s tougher rules have led to a fall in investor demand and falling investor demand is putting the brake on rising prices. As investors look to lower capital gain or even capital loss potential, demand will fall further, putting more pressure on prices.

The good news stems from the aforementioned rise in owner-occupier demand thanks to falling interest rates and less aggressive buyer competition. This is acting as a dampener on price falls. But lower rates also take the pressure off existing investors and the possibility of being forced to sell into a falling market, thus triggering a property crash. Investors may have to reduce rents to attract tenants but have a much better chance of riding out the downturn while loan repayments remain manageable, BIS Shrapnel notes.

The fact that Sydney and Melbourne have experienced the biggest rise in prices will be a key underlying factor behind the progressive weakening of prices over the next three years, BIS Shrapnel asserts. Price rises have fuelled further construction, and a record 49% of new completions across the country involve apartments. Victoria is forecast to tip into oversupply in 2016-17. Sydney will just hold on to undersupply.

The Perth and Darwin markets will continue to suffer from excess supply meeting the mining downturn. Adelaide faces the strongest economic headwinds, with the close of car manufacturing ensuring South Australia has the highest rate of unemployment in the country. Having already seen a solid drop in prices up to now, Brisbane offers the greatest prospect of rising house prices, BIS Shrapnel suggests, followed by Hobart and Canberra.

Nevertheless, all markets are forecast by BIS Shrapnel to experience falls in prices in real terms by June 2019. Real declines of 1% are forecast for Brisbane and Hobart, through to a 12% decline forecast for Adelaide. All capital cities are expected to see falls in apartment prices ranging from 8% to 15%.

Much has been made of foreign buyers forcing up the prices of new apartments. Foreign buyers are only allowed to purchase new dwellings, thus those looking to sell will only do so into a market of local buyers, BIS Shrapnel notes.

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article 3 months old

Treasure Chest: Aveo Group’s Retreat Presents Opportunity

By Eva Brocklehurst

Aged care services provider Aveo Group ((AOG)) is trading at a discount to its aged care and New Zealand peers, yet does not carry the same regulatory risk. Hence, Morgans considers this discount is undeserved.

The stock has recently slipped around 10% from its highs and the broker considers it is timely to accumulate exposure to its preferred retirement stock, upgrading to Add from Hold. A very strong FY16 result is expected, underscored by strength in both the residential retirement business and the non-core land bank. The broker believes there is risk to the upside if momentum in non-retirement sales and/or margins continues.

Brokers are mindful substantial cash from the sales of non-core business can be recycled into retirement developments and boost earnings. The stock is expected to meet its FY16 retirement returns target of 6.0-6.5%. Moreover, in FY17, further growth will be underpinned by the realised benefits from the Freedom acquisition. Morgans believes this should provide at least 6% earnings growth in FY17 and FY18 and contribute to the company growing its retirement returns to 8% by FY18.

The company has recently been able to increase its interest in unlisted Retirement Villages Group (RVG) via the buy-out of a number of minorities at a 20% discount to the current book value, with the consideration funded through its debt facility. Morgans calculates the acquisition of the remainder - 27% - would cost $100m and gearing would rise above the top of the target range.

The broker assumes the acquisition of the remainder would be earnings neutral, given the probability of an equity requirement. Unless the company decides to take gearing to a higher level.

Macquarie has noted that strong cash generated from the sell-down of the non-retirement developments should mean debt levels decline. The recent acquisition of the RVG minorities is modestly positive, in the broker's view, as the earnings yield acquired is greater than current interest rates. It also allows Aveo to take greater control of the business. Brokers expect the remaining investors will sell out in time.

Morgans envisages upside to RVG's valuation in coming years, with not only a revaluation of the book but also a roll out of the Aveo Way contracts across the portfolio. In the meantime, for Aveo, key catalysts to its valuation include the realisation of benefits from better quality contracts, an increase in new development sales and the expansion of care services.

Morgan Stanley has also stated a preference for Aveo Group, citing the success gleaned in New Zealand with its retirement model. The implementation of the Aveo Way strategy in Australia is expected to drive higher turnover and lower risk. Furthermore, Stockland ((SGP)) is expected to emulate the Aveo Way contract at generic villages, which involves a higher fee for certainty and an automatic buying back of the home. The broker expects higher returns for Aveo over the long term if this contract becomes the norm, although this is not a base case.

What is Aveo Way? The recently launched contract simplifies the financial model that prospective residents have to deal with when joining a retirement village. When the resident leaves the village the home is sold by Aveo and no marketing or refurbishment costs are required to be contributed in the process. There is also no capital gain or loss provided on the sale. Sales of homes are guaranteed within six months.

Aveo claims the contract is fairer and works for both the company and the residents. The company expects its financial model will be embraced over time by the sector and will reduce the negative perceptions surrounding village contracts.

There are three Buy and one Hold (Ord Minnett) ratings on FNArena's database. The consensus target is $3.72, suggesting 18.5% upside to the last share price. Targets range from $3.11 (Ord Minnett) to $4.35 (Macquarie).

See also, Anxiety Grows Over Planned Cuts To Aged Care Funding on June 8 2016.

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article 3 months old

Lower Fees, But Brexit Impacts On Macquarie Atlas

-Dulles Greenway action key to distributions
-Below trend traffic growth expected
-Question remains over manager


By Eva Brocklehurst

The outlook for Macquarie Atlas Roads ((MQA)) is sound, although brokers caution about the growth risk on the company's main toll road earner in France given the decision by the UK to exit the EU.

In an unrelated development, the external manager of the infrastructure fund, Macquarie Group ((MQG)), has lowered its fee base, citing the successful divestment of the Indiana toll road and the Chicago Skyway, which leads to a more streamlined portfolio and stronger corporate balance sheet.

Base management fees payable by Macquarie Atlas are reduced to a flat 1% per annum, which compares with the previous rates of 1.75% for market caps under $1bn and 1% for market caps over $1bn.

The reduction in this rate lowers Credit Suisse's base fees estimate by 12% to $31m for 2016 and by 24% to $28m for 2017. The present value cost of the management contract falls to $405m from $498m, which means shareholders have access to more value. This also suggests to the broker that a push for internalising management is likely to lose momentum.

Morgans increases its 2017-18 distribution forecast by 7% to account for the base fee savings and believes it reasonable to assume the new fee structure is permanent. The performance fee accrued for 2016 is $134.1m, below Morgans estimates of $144m, and the difference lifts valuation slightly. The performance fee is paid in scrip, which dilutes per share metrics.

No material changes are made to Credit Suisse's distribution expectations, as lower fees are expected to offset the recent strength in the Australian dollar against the euro and US dollar.

Morgans expects 2017 distribution guidance at the interim result in August and envisages a path to a step-change in the distribution in 2019 to more than 40c per security. The outlook for distributions will be influenced by the company's actions after its Dulles Greenway co-investor exits its stake later this year.

Macquarie Atlas will need to raise capital to buy the 50% stake, but could be a seller of its 50% if there is an attractive offer from a third party. Dulles Greenway is considered unlikely to start paying cash to Macquarie Atlas until 2019 because of lender distribution restrictions.

Thus, Morgans envisages retained cash plus distributions from APRR will need to support the company's distribution over a larger share base through to 2019 in the event the company acquires the Dulles Greenway stake. The broker upgrades its rating to Add from Hold.

Macquarie Atlas derives around 70% of its value from the APRR toll road in France and Credit Suisse suspects traffic growth may slow in the wake of declining business and consumer confidence following Britain's vote to leave the EU.

There is a second risk for the medium term if the Schengen agreement collapses and border controls are re-imposed across Europe. Credit Suisse estimates this could reduce cross broader freight traffic on the APRR. Hence, the broker maintains conservative traffic growth estimates of 1.9% for the second half of 2016, 2017 and 2018. This compares with first quarter traffic growth of 6.5%.

Of all stocks under coverage, Macquarie Atlas is the most exposed to EU growth concerns, Morgan Stanley maintains, although lower re-financing costs dominate the growth outlook in the near term. The broker envisages the UK decision may reduce growth for a number of years on APRR and the analysts expect a slowdown in EU GDP growth, which is reflected in base cast forecasts.

Still, marking to market bond yields incorporated in the broker's discount rates supports valuation and rating. Morgan Stanley believes the case for internalising the manager will grow stronger as the asset portfolio matures and is simplified.

Internalisation is the trend and Macquarie Atlas is the remaining listed infrastructure vehicle on ASX managed by Macquarie Group. The company has not commented on internalisation recently other than to reiterate that the board regularly reviews its position.

In the meantime, the broker believes the manager adds value by maximising corporate activity opportunities, such as a purchase or sale of Dulles Greenway or a capital restructure of the M6 and Warnow Tunnel. Longer term, the broker canvases several scenarios which range from Macquarie Group investing in more assets to divesting assets.

Macquarie expects another strong quarter in traffic will be reported in coming weeks with any impact from Brexit expected to emerge in the second half. This broker is also not expecting a repeat of the 6.5% growth seen in the first quarter and suggests it will take another 18 months until traffic growth returns to the long-term trend around 1.3%. Macquarie expects 2016 traffic growth of 3.3%.

In Dulles, Greenway traffic growth continues to benefit from the saturation on alternative routes. The broker believes current growth of 3.7% is conservative compared with first quarter growth of 7.3% Macquarie envisages the attraction of this road continues to grow, noting Macquarie Atlas is a net seller of assets where traffic is growing and demand for these assets is high.

Credit Suisse values the stock on a probability weighted scenario. The status quo suggests fair value implies a dividend yield of 3.2% for 2016 and 3.6% for 2017 and proportional enterprise value/earnings multiples of 14.5 for 2016 and 11.5 for 2017.

FNArena's database has five Buy ratings and one Hold (UBS, yet to update on the fee change). The consensus target is $5.38, suggesting 1.6% in downside to the last share price.

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