Tag Archives: Utilities

article 3 months old

Upper For Downer

Diversified engineering & construction conglomerate, Downer EDI, is expertly managing the move to infrastructure from resources but brokers believe this is largely reflected in the share price.

-Large potential in balance sheet for acquisitions and/or buy-backs
-Large amount of upside now factored into share price
-Citi: one of the best-placed options in the infrastructure sector


By Eva Brocklehurst

Engineering & construction conglomerate, Downer EDI ((DOW)), is moving with the times, countering the mining investment downturn with new business in infrastructure and ongoing work on the National Broadband Network. Net profit in the first half of $78m beat many broker forecasts, while FY17 net profit guidance has been raised by 7% to $175m.

The results beat Macquarie's estimates in four out of the six divisions, with the main surprise in technology & communications services, driven by a ramp-up in the NBN and Telstra ((TLS)) work. The broker expects these two should remain healthy contributors to Downer's income for the next 2-3 years, which highlights the benefits of the company's diversified nature.

The company has over $400m in potential capacity on the balance sheet for acquisitions and/or buy-backs, in Macquarie's calculations, and the earnings recovery for Downer has started earlier than expected, with 8.6% growth in prospect for FY18.

Soft Result In Utilities & Mining

The broker notes the completion of a major gas project and lower-than-expected profit from the Ararat wind farm muted the results in utility services in the half year. Moreover, the completion of the Christmas Creek contract contributed to a soft result in mining earnings, where EBIT declined 34%.

A $25m reduction in depreciation flattened the first half result, but as this relates to mining and the sale of some equipment, Macquarie does not believe it detracts from the services result, which was better-than-expected.

The company remains reasonably confident that the Adani Queensland coal project will proceed, having a letter of intent for both contract mining and the coal handling plant. However, Macquarie does not factor this into its forecast, nor has the company factored it into guidance.

While there is potential to exceed provides guidance and a high level of recurring revenues with low debt, Deutsche Bank is of the view that this is largely reflected in the share price, maintaining a Hold rating. Credit Suisse is even less enthusiastic, although concedes there was no hiding the strength of the result.

While it was hard to find an area that was disappointing the broker believes the outcome is reflected in the share price response. Credit Suisse upgrades its earnings base for FY17, assuming a similar, but now higher, earnings trajectory.

Record Work In Hand

Work in hand was a record $21.1m, reflective of recent wins in rail and around 58% of revenue being generated from public infrastructure clients. The growth outlook for transport, utilities and rail is strong while there are some headwinds across mining and engineering, construction & maintenance. Credit Suisse believes the business is exiting the high capex mining cycle in good shape, but this is reflected in the multiple.

The broker struggles to get its valuation close to the share price. Hence, an Underperform rating is retained. Nevertheless, Credit Suisse suspects this will be unlikely to compel holders of the shares to sell, particularly if they feel further earnings surprises can be delivered.

Morgan Stanley also suspects, despite the upgraded guidance, that downgrades to consensus EBITDA forecasts for FY17 are likely. The broker estimates that whilst FY17 net profit guidance implies around a 9% uplift to consensus, it is in fact a -7% downgrade to consensus EBITDA. The broker acknowledges the flexibility on the balance sheet and that a possible lifting of the final dividend has been flagged, but suspects the company's ability to fully frank this would be somewhat limited.

Citi notes management has taken definitive steps to restructure and appears to be managing the downturn in resources, shifting the portfolio towards the growing infrastructure and utility sectors. The broker is of the view that the exposure to public infrastructure investment puts it in a robust position for the medium term. While the 50% jump in the share price since the FY16 result has anticipated this to some extent, the broker still believes the stock is one of the best placed options in the sector.

FNArena's database shows one Buy (Macquarie) rating, three Hold and one Sell (Credit Suisse). The consensus target is $6.25, signalling -9.9% downside to the last share price. This compares with a target of $5.54 ahead of the results targets range from $4.01 (Morgan Stanley) to $7.45 (Macquarie).

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article 3 months old

What Does Hazelwood Closure Mean For AGL?

French owner ENGIE has announced Victoria's Hazelwood power station will close in March and higher wholesale electricity prices are expected as a result.

-AGL Energy a beneficiary as it is highly leveraged to Victorian wholesale electricity prices
-Closure of Alcoa's Portland aluminium smelter now considered more likely
-Questions raised over which other power stations may be facing closure


By Eva Brocklehurst

French owner ENGIE will close Victoria's Hazelwood power station and associated brown coal mine in March 2017. This is consistent with the company's strategy to exit coal activities. Hazelwood recently supplied around 20% of Victoria's electricity generation. As a result, the upcoming closure is expected to substantially tighten the supply/demand balance in the wholesale electricity market in Victoria from 2017, and make prices more volatile and higher on average.

What does this herald for AGL Energy ((AGL)), Victoria's largest base load power station operator? With substantial upside risks to wholesale electricity prices AGL would be the main beneficiary, as it is highly leveraged to Victorian wholesale electricity prices because of its ownership of the Loy Yang A coal-fired power station. Deutsche Bank calculates that every $15/MWh move in the Victorian wholesale electricity curve represents around $150m of incremental net profit for AGL, once legacy hedges have rolled off.

Brokers also believe the closure of Alcoa's Portland aluminium smelter is now probable, given the associated change in the Victorian wholesale electricity forward curve from the exit of Hazelwood. Given its high consumption of electricity closure of Portland would help mitigate the tightness in the Victorian wholesale electricity market.

Macquarie believes scope exists for the simultaneous closure of Hazelwood and Portland. This would bring stability and balance to the Victorian base load market. AGL is the biggest winner in this scenario.

The broker expects there to be some negative response to the Hazelwood closure and subsequent price rises, in terms of demand, which is likely to be more prominent at the retail level. Yet broadly the fundamentals are unchanged, as forward curves continue to signal a strong, and now more balanced, wholesale base load market. The uplift to AGL earnings should underpin continued cash generation from re-pricing across the company's books, in the broker's view.

Citi upgraded earnings estimates for AGL substantially back in September, when the closure of Hazelwood loomed likely. The broker suspects higher electricity prices may start to be incorporated in consensus estimates but the near-term prospect of Portland's closure, and Loy Yang industrial action, may mean that upgrades are slower to eventuate.

AGL's share price has recently disconnected from wholesale electricity prices, which the broker attributes to the company's conservative commentary at the FY16 result. Citi envisages material upside to the share price as investors regain confidence in the earnings outlook.

The broker notes reduced flexibility in gas markets also limits the ability to cheaply support peak electricity demand, and with ENGIE leaving the market it reduces the liquidity in electricity contract markets, creating price pressure for non-integrated retailers. The broker agrees the closure of Hazelwood is constructive for AGL as electricity prices are the company's biggest driver of earnings, and this more than offsets the risks from closing Portland.

On the subject of Portland, Citi believes closure is very likely and already factored into wholesale prices. The size of the subsidy required to keep it open would make it incredibly difficult for the Victorian government to justify protecting an estimated 500 jobs and 200 contractors. At Loy Yang A, AGL is currently negotiating with the union on a new enterprise bargaining agreement.

Citi also suspects that the closure of Hazelwood will provide an opportunity for coal generation in NSW and Queensland to run harder where spare capacity exists. Origin Energy's ((ORG)) Eraring power station in NSW has the greatest potential to increase generation above its current capacity of 50-60%, because of its location close to the Newcastle coal export terminal.

AGL's MacGen in NSW is already at close to its age-limited capacity and Mt Piper is limited because of its inland location. The broker highlights the fact that the age of the Australian coal-generated power station fleet limits the ability to run them consistently at maximum production without risking breakage.

Outside of Hazelwood (50 years old) and Liddell (NSW) (40 years old), the broker surmises that a further seven power stations that are over 30 years old are less likely to close for now. The wild card in the mix is any government carbon/renewable policy changes, which further incentivise renewables and accelerate coal closures.

Further to speculation regarding other power station closures, Ord Minnett suggests old power stations in Victoria, such as Yallourn, could be targeted next by activists. ENGIE will appoint an advisor for the sale of its 1,000MW brown coal-fired Loy Yang B and the 123MW gas-fired Kwinana co-generation operation in Western Australia. The broker finds it hard to envisage a local buyer for Loy Yang B, as competition obstacles are likely to rule out AGL and Energy Australia and a focus on de-leveraging rules out Origin.

Being mindful that two brokers are yet to update on the implications of the Hazelwood closure, FNArena's database has five Buy ratings and one Sell (Morgan Stanley) for AGL. The consensus target is $21.18, suggesting 8.3% upside to the last share price. This compares with $20.22 ahead of the announcement. Targets range from $18.80 (Morgan Stanley) to $23.00 (Ord Minnett).

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article 3 months old

AGL Brightens Outlook With Capital Returns

AGL Energy has announced capital management initiatives, welcomed by brokers, and its near-term outlook looks considerably brighter.

-Upgrade of dividend pay-out and buy-back announcement increases confidence in earnings outlook
-Uncertainty over the closure of Alcoa's Portland and/or the Hazelwood brown coal power station
-Share price disconnect from electricity prices over recent weeks seen as a buying opportunity


By Eva Brocklehurst

AGL Energy ((AGL)) has announced capital management initiatives at its annual general meeting which are supported by the higher wholesale electricity prices flowing through to customers. The near-term outlook appears considerably brighter to brokers, given AGL is the largest beneficiary of strong wholesale electricity prices, and with the gas business going backwards this year because of increased spot sales at higher prices.

The company has provided FY17 guidance for profit of $720-800m, with contributions expected to come from wholesale electricity margins and the delivery of operational transformation targets. AGL is raising its dividend payout ratio to 75% of underlying profit and targeting a minimum franking level of 80%. This replaces the company's current progressive dividend policy which has resulted in a pay-out ratio of around 60-65% over the past five years. AGL intends to carry out an on-market buy-back of up to 5% of issued market capital (around $600m).

In applying the new guidance to FY17 earnings forecasts, Deutsche Bank estimates a dividend of 84c per share in FY17. The upgrade of the dividend increases confidence in the earnings outlook and while the guidance range is wide, it is not uncommon in Macquarie's view and likely relates to AGL being cautious about the competitive environment. The announcements suggest confidence in the cash flow and probably reflect a recent decision to move from acquiring any of the Alinta assets, Ord Minnett suggests.

There is potential for more buy-backs, brokers believe. Credit Suisse, adjusting for dividends, estimates AGL will generate $600m in free cash flow pre-growth, and $400-450m per annum after growth capital expenditure in FY17-19. The company is pursuing a light approach to renewables and there are limited opportunities elsewhere so Credit Suisse expects more buy-backs.

Capital management was the key issue weighing on broker minds, Macquarie believes, given the disappointment at the final result when nothing was announced. The timing, at the AGM, is ahead of Macquarie's expectations and largely reflects the fade of near-term acquisition opportunities and renewable investment being largely off balance sheet. The broker believes strong cash generation provides scope for the buy-back to continue in coming years and also provides additional flexibility above the current pay-out range.

Deutsche Bank had erased expectations of capital management in 2016, as the company's commentary at the results in both February and August seemed to suggest it favoured a growth focus. The turnabout probably, in the broker's opinion, reflects the 15% sell-off in the stock over the last six weeks, which has made buy-backs a more productive use of cash flow, particularly as the earnings outlook has stayed robust.

Allowing for higher dividends, capital management, and the unchanged credit rating from Moody's, Morgan Stanley estimates there is head room to pursue growth initiatives of up to $2.5bn and looks forward to the investor update scheduled for November.

Recent speculation in the Victorian market regarding potential closure of Alcoa's Portland smelter and/or the Hazelwood brown coal power station continue to provide uncertainty. Macquarie expects the closure of Hazelwood to be brought forward to the second half of FY17 which would be positive for AGL, although the benefit may take some time to be visible as hedging contracts need to be renewed. The closure of both facilities would be a net reduction in generation of 7TWh.

The broker expects that over 2-3 years renewables will start to enter the Victorian market, particularly wind. Given the correlation between wind farms in South Australia and Victoria, price volatility is likely to emerge which the broker expects would favour the tier 1 retailers such as AGL. Deutsche Bank agrees that AGL would be a key beneficiary of any decision to close Hazelwood, given the company's substantial leverage to Victorian wholesale electricity prices.

Equity market and electricity futures have diverged, Credit Suisse observes, which suggests the electricity market is giving more credence to the closure of Hazelwood than the equity market. The broker believes the speculation illustrates the inter-dependency between closure of Hazelwood and closure of Portland smelter, which is commonly cited as a downside risk for AGL. The broker believes divergence between AGL stock and the electricity curve has become too great and upgrades to Outperform from Neutral.

Citi also upgrades its recommendation, to Buy from Neutral, believing the case for higher electricity prices has strengthened, based on the likelihood of a Hazelwood closure and reduced flexibility in gas markets to support peak electricity demand. The broker raises electricity price forecasts by 5-9% for FY18 and 6-25% for FY19. Citi agrees the share price has disconnected from electricity prices over the past month and this provides a clear buying opportunity.

One of the issues Ord Minnett has with AGL's strategy is that it is not necessarily conducive to changing the company's mix in generation and increasing the proportion of renewables. AGL has reiterated that a capacity payment is the best way to incentivise generators to build new renewable capacity but the broker does not believe there are any immediate plans for this to be implemented across the national electricity market. That said, the broker concedes most of the negatives surrounding the stock have dissipated and retains an Accumulate rating.

AGL has five Buy ratings and one Sell (Morgan Stanley) on FNArena's database. The consensus target is $20.10, suggesting 3.7% upside to the last share price. Targets range from $18.13 (Morgan Stanley) to $21.00 (Ord Minnett). The dividend yield on FY17 and FY18 estimates is 4.2% and 4.6% respectively.

Goldman Sachs, not one of the eight brokers monitored daily on the database, believes the capital return sends a clear signal that AGL is no longer pursuing industry consolidating deals and provides some insight into what the company considers is intrinsic value. The broker has a Neutral rating and $19.50 target.

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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

Diamantina Deal Positive For APA And AGL

-APA obtains growth and cash flow
-AGL closer to targeted asset sales
-Goldman upgrades APA to Buy


By Eva Brocklehurst

Brokers welcome the deal struck between joint venture partners in the Diamantina power station, AGL Energy ((AGL)) and APA Group ((APA)), believing it signals a positive outlook for both companies. AGL will offload its 50% stake in Diamantina, central Queensland, to APA for $151m, representing a small premium to book value.

The sale of the stake did not surprise Macquarie. In APA's hands the business will benefit from being part of a broader group and thus debt amortisation can be deferred. Now, post the sale of solar and gas assets, AGL should have around $900m in surplus capital that can be used for capital management. This is further evidence for the broker that AGL continues to implement its change in strategy, delivering flexibility so it can manage the uncertainty around electricity generation.

The transaction is also attractive for APA. Macquarie calculates the equity return is around 14% based on a conservative debt amortisation policy and zero terminal value in FY31. The broker anticipates that there will still be a need for residual back-up power, namely gas-fired generation, despite technology evolving in terms of battery/solar/wind by that date.

The returns stack up as APA is able to defer its debt amortisation schedule to the latter half of the project. From a cash flow perspective the company will enjoy $40-45m in additional flow and a constant debt for the next six years. Operating cash flow expectations have now been raised by 2.5% and 4.5% respectively for FY16 and FY17 and Macquarie notes, while dividend guidance is maintained, APA has a habit of surprising on the upside.

Morgans believes this move to mop up Diamantina, plus the bid for the 94% of Ethane Pipeline ((EPX)) it does not own, are indicative of the limited opportunities available to APA to deploy growth capital into its gas pipeline business. Falling commodity prices have reduced customer needs for additional gas haulage and storage services, which makes a continuation of the company's $300-400m per annum growth capex guidance beyond FY16 difficult to achieve.

The acquisitions will be accretive to cash flow, but this is not surprising to Morgans given they will be initially funded with low-cost bank debt. The broker expects Diamantina will add $88m per annum initially, with revenue certainty until 2030 supported by a tolling agreement with Glencore and Ergon Energy.

The 242MW Diamantina station and the nearby 60MW Leichhardt power stations were developed and built jointly by APA and AGL. APA will take on board the long-term service agreement with Siemens as well as the 17 staff currently operating the power station.

APA has no wholesale electricity price exposure, as nearby Mt Isa is not connected to the national electricity market. Gas is being supplied to the plant by AGL for the initial 10 years of operation with offtakers required to source the fuel gas thereafter.

APA obtains much needed growth and immediate cash flow accretion, while the asset is non-core to AGL and takes the company a step closer to its $1bn in targeted asset sales by 2017, Ord Minnett notes.

The broker revises long-term assumptions for APA, which moderates valuation, but retains a preference for the stock in the sector as it is likely to be the beneficiary of ongoing development in the domestic gas industry. The broker is also positive on AGL, given its exposure to increasing wholesale electricity prices.

APA has recently underperformed its defensive peers and Goldman Sachs believes this is an over-reaction to comments from the regulators regarding the east coast gas market. The broker believes the stock is a relatively low risk way to gain exposure to east coast gas system growth. Goldman, not one of the eight stockbrokers monitored daily on the FNArena database, upgrades the stock to Buy from Neutral.

Increased regulation could affect the long-term earnings impact of APA's key pipelines but the these may be long dated and muted by commercial offsets, the broker maintains. The two pipelines most at risk of regulation are the South West Queensland pipeline and the Moomba-Sydney pipeline. The QCLNG/WGP pipeline is not expected to be regulated as its function is to transport gas to the QCLNG project.

Goldman makes reductions to medium-term earnings forecasts based on a review of tariffs and capacity sales but considers this more than offset by the full consolidation of the Diamantina power station.

FNArena's database has three Buy ratings for AGL, with four Hold. The consensus target is $19.57, suggesting 6.9% upside to the last share price. Targets range from $18.66 to $20.55. For APA there are five Buy and three Hold ratings. The consensus target is $9.41, suggesting 5.8% upside to the last share price. Targets range from $8.70 to $10.65.

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article 3 months old

Weekly Broker Wrap: Automotive, Utilities, Prostheses List, Grocery And BWX in China

-Import changes slightly negative for APE, AHG
-Wholesale electricity tailwind for utilities
-Woolworths sales remain under pressure
-BWX's substantial growth opportunity


By Eva Brocklehurst


From 2018, consumers will be able to directly import new cars or motorcycles. They will need to meet Australian safety standards, be right-hand drive and less than 12 months old with less than 500,000km on the clock.

The special import duty on used vehicles will also be removed. At present only Japanese and UK cars meet the standard for import but legislation is planned to change this although there is some early opposition to the changes.

Credit Suisse does not expect a material impact on new or used vehicle prices but believes the change will be a negative for AP Eagers ((APE)) and Automotive Holdings ((AHG)), albeit modest as the dealers are predominantly exposed to the mass market.

Fleet providers such as SG Fleet ((SGF)) and Eclipx ((ECX)) are likely to be unaffected. Leasing providers such as McMillan Shakespeare ((MMS)) and Smartgroup ((SIQ)) are also likely to witness few changes, the broker believes, as novated leasing demand is more influenced by new car sales and finance trends while fringe benefits tax is a more significant issue.


The improving outlook for wholesale electricity prices represents a key tailwind for utilities in 2016, Deutsche Bank maintains. Regulated utilities such as Spark Infrastructure ((SKI)), DUET ((DUE)) and AusNet Services ((AST)) face significant final determinations in their Victorian electricity distribution networks.

The broker believes the sector will outperform on earnings growth, sustained low bond rates and improving wholesale electricity prices. APA ((APA)), AGL Energy ((AGL)) and Spark Infra are considered best leveraged to this theme and remain the broker's preferred exposures.

Prostheses List

The federal minister has promised to prioritise prostheses pricing reform and Deutsche Bank regards this a s a medium-term positive, as it should reduce affordability pressures that are driving increased churn for insurers and policy downgrades.

In the near term the earnings impact could be negative for the insurers if the government ensures savings are passed onto consumers through lower premium rises.

Public hospitals are able to shop around for prostheses but the private health insurance industry is required to pay a fixed price to private hospitals based on the prostheses list, and these prices are considered well above domestic and international benchmarks.

Goldman Sachs expects any near-term financial impact on funds such as Medibank Private ((MPL)) and nib Holdings ((NHF)) will be small, if impacting at all. There will be a negative impact on medical device company gross profits in Australia and, in turn, they may seek to reduce any volume rebates they currently pay to hospitals.

Goldman downgrades earnings forecasts by 3.0% for Healthscope ((HSO)) and by 2.0% for Ramsay Health Care ((RHC)). UBS notes both these private hospital operators have previously insisted they would be relatively unaffected by cuts to the prostheses list but at this point makes precautionary reductions to estimates.


Competition among grocery stores in Australia has reached new heights, Goldman Sachs maintains, as Woolworths ((WOW)) attempts to resurrect its sales with investment in price, service and inventory.

The broker notes Coles ((WES)) and Metcash ((MTS)) have responded with their own initiatives, keeping any resurgence at Woolworths at bay. Aldi's market share growth, meanwhile, appears to be coming at the expense of Woolworths and Metcash.

The broker compares the Woolworths sales decline with Tesco in the UK, where competition led to a fall in margins, earnings and a sharp decline in the share price. There are some mitigating factors for Woolworths compared with Tesco, the broker acknowledges, given its greater market share and Australia's low population density.

Goldman also revises earnings estimates down for both Woolworths and Wesfarmers in the light of softening food statistics. Margins are forecast to decline at Woolworths and remain flat for Coles.


Natural skin care product manufacturer BWX ((BWX)) delivered a substantial increaese in interim earnings, up 62%, which for brokers underscores the company's strong potential.

Bell Potter observes the flagship Sukin brand continues to deliver exceptional domestic sale growth and is now poised for a material opportunity in the Chinese market. The broker retains a Buy rating and $3.90 target.

Moelis notes the gross profit margin expanded by 410 basis points as the company transitions from low margin, low volume third party manufacturing. BWX is now net cash. The broker retains a Buy rating and $4.65 target.

Exports commenced in FY16 and this is expected to be the main driver of offshore revenue. The company owns the formulations for all five of its brands Moelis believes the stock is another way to play the growing consumer demand for high quality Australian goods in China.

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article 3 months old

Weekly Broker Wrap: SMSFs, Franking, Building Materials, Bank Capital, Wealth And Utilities

-Self managed super growing strongly
-James Hardie constrained by Texas
-Boral supported by Oz infrastructure
-Revised Basel rules but uncertainty prevails
-Fund flow growth slows but still healthy
-Policy uncertainty a headwind for utilities


By Eva Brocklehurst

Self Managed Super Funds

Self Managed Super Funds, or “selfies”, have had a torrid time this year, Credit Suisse maintains. They are on track to record capital losses for the third quarter in a row. As a consequence, selfies as a proportion of the $2 trillion Australian pension pool are reducing.

While there were comparable dollar losses in the rest of the superannuation fund segment these were smaller as a proportion of total assets. Allocations to Australian equities by selfies have fallen to 39% of current portfolios from 41% a year ago.

Despite this fact, the broker notes they remain the most important pension investor in Australian equities, owning 16% of the market versus 11% for retail funds and 7.0% for industry funds. Importantly, selfies are growing in numbers as members roll over funds from other superannuation vehicles.

The broker observes this will continue as the country's pension scheme ages and selfies will underpin the dividend trade in Australia. They are committing more new money to Aussie equities than any other group and the segment is winning new members at the expense of the rest of superannuation industry.

Their second biggest asset is Australian cash at 27% of assets under management and the third is Australian property, at 25%. Credit Suisse estimates their property positions have increased by two percentage points over the past 12 months.


Macquarie has analysed its data and research on franking, comparing companies against sector peers and looking at franking credits as a percentage of market capitalisation. Fortescue Metals ((FMG)) has moved into the top five in terms of the highest franking credit balances while Commonwealth Bank ((CBA)) has fallen in rank, albeit still increasing its franking balance to $569m this year from $533m last year.

In the lowest value end of the scale, Village Roadshow ((VRL)) has moved into the bottom five while Aurizon ((AZJ)) has come out. Aurizon's franking balance has moved from negative to $76m.

Macquarie also notes Harvey Norman ((HVN)) continues to have a high franking account balance compared with other companies in the ASX100, although its balance has dropped in 2015 to $584m from $659m. Fairfax Media ((FXJ)) has a comparatively low franking balance which has gone backward since 2013 when compared with other stocks in the ASX100.

Building Materials

Credit Suisse has surveyed US real estate agents and notes their concerns around the shortage of quality homes amid buyer resistance to higher prices. Home buyers constrained by job security were sharply in evidence in Texas, while several markets noted a material slowing in foreign buyers, which has taken the heat out of the market.

The broker believes this warrants caution around the broader housing market as the slower winter months get under way. This could be aggravated by affordability issues following recent increases in mortgage rates.

Texas accounts for around 25% of James Hardie's ((JHX)) total US fibre cement volume and is also one of the company's more profitable regions. James Hardie is also is overweight in the city of Houston, where activity according to the survey fell to its lowest level since the global financial crisis.

Credit Suisse expects the stock to be range bound until the secular growth story is restored. The company is also further impaired by a capital management story that has largely played out.

The broker estimates 20-25% of Boral's ((BLD)) US revenue is derived from Texas, accounting for 2-3% of the group. Still, a number of catalysts should support the company's earnings, with the broker anticipating the emerging Australian east coast infrastructure cycle.

Bank Capital

The latest Basel revisions to bank capital rules appears to be softening relative to last December's proposal, Macquarie observes. Uncertainty surrounding implementation and interpretation continues but the broker suspects risk weighting on standardised mortgages is likely to be lower than previously expected.

The broker also observes that while banks took the opportunity to raise pricing on investor portfolios relative to the owner occupier part of their book, the capital backing for these exposures has not materially changed.

Assuming regional banks are able to continue to utilise the lender mortgage interest capital offsets, Macquarie considers the revisions are a better-than-expected outcome for the regional banks. The broker continues to envisage upside risk to bank valuations as the sector yield gap to the industrials narrows.

JP Morgan considers the revised proposals maintain the pressure on the major banks to progressively build capital over coming years. The broker observes some headwinds across the corporate and credit card book but the biggest unknown is with mortgages.

Significantly higher risk weights for investor mortgages should be a key swing factor that the broker believes is open to interpretation on the basis of whether loan servicing is materially dependent on rental income.

The broker envisages overall risk weights across the regional bank portfolios as unchanged, with higher investor risk weights offset by lower owner occupied risk weighs for higher loan-to-valuation ratio mortgages.

The risk weight floor for advanced accredited banks for investor mortgages still largely remains an academic exercise, in the broker’s view. JP Morgan works with an assumption of an 80% floor.

Wealth Manager Retail FUM

Statistics from the September quarter indicate that weaker markets are affecting investor appetite, although UBS observes net inflows to wealth manager retail funds remain at quite healthy levels.

Flows have now remained at around $20bn for nearly two years and, as a consequence, growth from flows into funds under management (FUM) has declined to 3.1% from 3.8% over this period.

This level of flow was not sufficient to offset the impact of equity market declines, which reduced FUM by 2.0% in the quarter. While not the best quarter for AMP ((AMP)) the stock remains the broker's preference as a defensive wealth manager, versus pure-play fund managers such as BT Asset Management ((BTT)), as it is considered to have more leverage to reduced investor flows and markets.


Morgan Stanley believes the climate agreement in Paris has a low immediate impact on Australian utilities because the agreement was well flagged by the US and Chinese delegations, and because implementation in Australia will only follow in 2020.

The broker expects Australia's emissions reduction will require an evolving of the government Renewable Energy Target (to be reviewed in 2020) and its Direct Action plan. In the meantime, uncertainty in emissions reduction policy will be a sector headwind, in Morgan Stanley's view, as it hampers capex planning for the utilities under coverage. This contributes to a Cautious industry view.

DUET's ((DUE)) Energy Developments business is a beneficiary because its revenue and development prospects rely, in part, on emissions reduction policies. The broker's base case is a modest carbon price from the early 2020's, continued deployment of both large and small scale renewables and an orderly shift in the mix of coal-to-gas-to-renewables in thermal generation and oil-to-electricity in transportation.

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Weekly Broker Wrap: Insurers, Banks, Utilities, Online Portals And iSelect

-Insurer growth lacklustre
-More re-pricing from banks?
-Yield and growth in utilities?
-REA Group winning online
-ISelect now has cash


By Eva Brocklehurst

General Insurers

Macquarie has reviewed the general insurers under its coverage, ranking them in terms of premium growth, margin pressure and key issues such as currency and cost cutting. The broker's top pick is QBE Insurance ((QBE)) which enjoys positive currency and interest rate tailwinds relative to its peers. The capital re-build is complete and the company is focused on core business.

Next up is Suncorp ((SUN)), which has earnings momentum and the best expense ratio, well placed to access newly privatised markets in coming years. After that comes Insurance Australia Group ((IAG)), which appears to be constrained in terms of premium growth. Multiples are full and without the prospect of imminent capital returns. While insurance margins are the highest of the three this suggests to Macquarie a greater vulnerability to challenger brands.

UBS finds compelling reasons to be a seller of general insurers. The broker expects gross written premium to track sideways, with downside risks. Questions could be raised at the results around margin sustainability and the answers may only become clearer as FY16 progresses.

The broker considers many of the events of recent months have been a distraction and looks for answers as to why IAG needed to free up $1bn in capital through a deal with Berkshire Hathaway.

The broker is mildly optimistic that QBE will have fewer complicated issues this time around, with a positive message on dividends likely. The next 12 months are considered critical for Suncorp's investment case, largely because of the broker's more conservative view on general insurer margins as rate pressures flow through.


UBS has downgraded earnings forecasts for FY17 for the major banks in the wake of statements from APRA which provide more clarity on the capital shortfalls. Three of the four have re-priced investment property loans in order to slow credit growth to below the APRA macro prudential thresholds.

This suggests the banks are moving to pass on some of the costs of higher capital requirements to customers and UBS considers this a smart move. The broker expects the spread between owner-occupier and investor mortgages to widen further as the banks continue to re-price these loans.

The broker also considers it likely the banks will look to rights issues to improve capital requirements. This may be an opportunity to increase exposure to the banks and participate in re-pricing upside.


UBS likes regulated utilities which offer yield and growth potential. On this basis the broker prefers APA Group ((APA)) and upgrades to Buy from Neutral. The stock offers the best quality in terms of distributions and these are more than covered by free cash flow. DUET ((DUE)) and Ausnet ((AST)) are best in terms of up-front returns. DUET is rated Buy, with good yield and growth prospects on the back of the proposed acquisition of Energy Developments ((ENE)).

Ausnet and Spark Infrastructure ((SKI)) are rated Neutral. The broker considers the grossed up distribution yield of 8.0% is factored into Ausnet's price. Spark Infrastructure ranks poorly on distribution coverage and is the least attractive on an enterprise value/regulated asset basis despite strong growth forecasts.


Citi reviews online usage metrics across the desktop and mobile sectors in order to determine winners in the battle between REA Group ((REA)) and Fairfax Media's ((FXJ)) Domain portal. The broker looks closely at relative share, given the importance placed on being No 1 in online classified verticals.

Data from the Nielsen ratings shows Domain is closing the gap in terms of unique audience but on total page views the gap is actually increasing, which the broker considers is a better measure of engagement. This gap is widening despite Domain's push into new markets.

Mobile adds impact for both players and the gap appears constant. Mobile is driving increased engagement by consumers with the portals and is this is not unique to property. The discovery process appears to be via desk top mid week but reverting to mobile on the weekend. Nevertheless, it appears REA Group is retaining its number one position across online.

Citi rates REA Group as Buy and Fairfax as Neutral. Domain has a solid position in Sydney and Melbourne, supported by legacy print classifieds, and remains positioned for growth, which the broker considers is priced into the Fairfax valuation.


ISelect ((ISU)) has agreed on a cash settlement for its outstanding NIA Health loan facility. Bell Potter welcomes the agreement and makes minor upgrades to forecasts because of changes in interest rate assumptions. The broker also adds a 15% premium to valuation to account for the prospect of capital management initiatives. As a result the price target is raised to $2.10 from $1.65. A Buy rating is retained.

The broker likes the agreement as the company can focus on its underlying business now the distraction has been removed. ISelect will have more than $100m in net cash on the balance sheet after settlement of the NIA deal.

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article 3 months old

Weekly Broker Wrap: Oz Housing, Jobs, Wagering, Telecoms And Utilities

-Is Oz house construction peaking?
-RBA's cash rate key to housing
-Strong jobs, weak wages
-Wagering set for solid growth
-Accelerating mobile revenues
-GS prefers SKI, DUE for yield


By Eva Brocklehurst

Australian Housing

Housing is one of the few bright spots in the economy but this is set to change. Much attention has been given to price rises in Sydney but construction, too, is in a sizeable upswing. Dwelling construction has added half a percentage point to GDP growth over the past year, offsetting part of the percentage point drag from weaker business investment. Alliance Bernstein suspects this might be as good as it gets. Underlying demand for new housing to meet population growth has slowed to 120,000 per annum from 180,000. While there was a prolonged period of under-building this has now swung to over-building. At the end of the year it is likely that housing construction will be running above 6.0% of GDP, a level not seen since the early 2000's.

Rental growth has slowed to just 2.0% now from mid to high single digits in 2008/09. House price growth outside Sydney has slowed too. Growth in Perth and Brisbane is now negative. Alliance Bernstein also believes there is a technical "wild card" to consider. An historically disproportionate share of the upswing is multi-storey apartments and a lot of this activity is driven by foreign investors. With greater scrutiny of the rules there is potential for a change in this area. Alliance Bernstein is not suggesting a housing collapse, particularly as the upswing has not been accompanied by rampant growth in credit. Still, it is considered inevitable that there will be a downturn by mid next year.

UBS also grapples the issue of whether housing is in a bubble. In the broker's opinion the main driver of a stronger-for-longer home building boom is the Reserve Bank's cash rate staying at current levels for another year. It remains at a record low 2.0%. This is the key catalyst for housing approvals, not supply or unemployment, UBS maintains. UBS expects record commencements in 2015 and 2016, which should allow supply to catch up to demand but only making a small dent in the under-building which has accumulated over some years.

UBS agrees that the record high investor/medium-density share of the upswing is a risk but believes this is suppressing rents rather than prices, as unemployment is not spiking. Regulation is also not seen as a material dampener of demand in the months ahead. Moreover, amid record low interest rates, the mortgage repayment share of income is around average. Hence, while there are bubble-like features in the current cycle, UBS does not observe any trigger that will pop them in the near term.


UBS asks the question whether the latest data on employment from the Australian Bureau of Statistics can be believed. As this is a survey covering only 0.32% of the population the 95% confidence interval range on jobs is large at 166,000 month on month. In May, jobs growth doubled and unemployment fell to a one-year low of 6.0%. Hours worked were flat and strong growth in Western Australia meant its unemployment rate fell back to the lowest among the major states, which does not fit with the mining downturn. Gains have also been unusually concentrated by industry.

UBS suspects, amid the negative income shock from the terms of trade, labour market flexibility is allowing for much of the necessary adjustment via wages rather than job numbers. Wage rates are growing at a record low rate, GDP-based employee compensation is below 2.0% and company profits are flat, which indicates a large degree of labour market slack. However, it suggests unemployment should be rising not falling. The broker suspects the reality is somewhere in between. The US experience after the GFC revealed there an be a prolonged period of job retention coinciding with weak wages.


Morgan Stanley lifts medium-term wagering growth assumptions. The broker believes the market is underestimating the positive changes occurring in the industry. This include mobile usage, competitor consolidation, race field fees and fixed odds betting, with operators intent on innovation instead of price wars. The broker expects the industry to grow at 7.0% for 2016 and 2017 versus a rate over previous years more like 3-4%.

Product innovation and advertising spending should drive both penetration and spending frequency. Morgan Stanley's survey also suggest younger players are more likely to bet online on sports. Tabcorp ((TAH)) and Sportsbet will be the main beneficiaries of improved industry economics, in the broker's opinion. 

The introduction of "in-play" betting via the internet should grow total turnover and revenue in Australia's wagering market, in Macquarie's opinion, given evidence from European operators that it can generate increases in sports wagering. Macquarie believes online corporate bookmakers have been gradually eroding the retail advantage of Tabcorp and Tatts ((TTS)). While a relaxation of the rules is considered inevitable, Macquarie does not factor this into forecasts at this stage. Still the whole industry is well positioned for the uplift from online and this underpins the broker's Outperform ratings on the latter two stocks.

Mobile Services

After some years of low returns the Australian mobile industry is delivering returns approaching the cost of capital. All operators appear to be participating in accelerating revenues. Capital intensity has continue to rise but the industry has benefitted from cost cutting and improved pricing power following consolidation.Goldman Sachs expects operators to retain their price discipline. The broker's analysis provides greater confidence in continued multi-year mobile industry growth. Telstra's ((TLS)) service revenue forecasts are retained and this is expected to underpin low single digit group earnings growth over FY15-16.


Goldman Sachs recently met management from five Sydney-based utilities.The broker notes Origin Energy ((ORG)) has been volatile with an increased focus on the potential for LNG oversupply. The company is upbeat about its retail margin outlook and increased pricing power in NSW. The broker continues to believe oil prices and the start of Sinopec deliveries will be key for the company. AGL Energy ((AGL)) is optimistic on electricity pool prices as Gladstone LNG will ramp up exports through FY16. Goldman notes there is too much regulatory uncertainty for the company to confidently invest in more wind capacity.

APA Group ((APA)) is considered well positioned to take advantage of its opportunities, although growth appears priced in. Spark Infrastructure ((SKI)) plans to bid on the three NSW network utilities and any transaction here would be highly material to growth, although Goldman Sachs emphasises the multiples paid will be important. DUET Group ((DUE)), meanwhile, has been short listed for the NT link project and could be in a position to buy Chevron's Gorgon domestic gas pipeline if sold. The broker prefers the latter two stocks because of the superior near-term yield.

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article 3 months old

Weekly Broker Wrap: Oz Insurers, Techs, Advertising, Papers And Solar

-Insurer challengers resilient
-Global advertising robust
-But big clients review accounts
-Questions re print advertising
-AGL, ORG need to respond to solar


By Eva Brocklehurst

Australian Insurers

As Insurance Australia Group ((IAG)) and Suncorp ((SUN)) have quantified natural peril losses for FY15, UBS suspects it will turn out to be the worst year for weather events in a decade. The broker disagrees with emerging bullish views which believe pricing in general insurance will firm up and the challenger brands will fall by the wayside. Despite appealing valuations, UBS retains a cautious outlook until margins re-base to more sustainable levels.

Since 2010/11 the challenger brands have been able to grow without operational strain or financial cost associated with significant weather events. 2014/15 was the test. UBS estimates Youi incurred around $110m in gross catastrophe losses in FY14, with $40m retained and $70m passed on to reinsurers. While this will hurt it is unlikely to undermine the business model, in the broker's view. Concerns around the challengers' service levels are overstated, UBS maintains, as Auto & General and Hollard continued to deliver premium growth of 15-20% over 2010/11, despite elevated levels of complaints to the financial ombudsman over that period.

Techs, Media & Telcos

Bell Potter has updated its key picks in the emerging tech space with Integrated Research ((IRI)), Empired ((EPD)) and Appen ((APX)) the top three. The broker now has two Sell rated stocks in the segment - Technology One ((TNE)), as it now looks expensive, and Vocus Communications ((VOC)), for which the first half showed slowing growth in the core data business. The broker hastens to add that neither of these Sell ratings suggest there is anything fundamentally wrong with these businesses. The ratings are driven by valuation.

Advertising & Newspapers

Citi has reviewed the commentary from over 40 global advertisers and concluded that the outlook is robust, although agencies are under pressure from clients with a number of large accounts being reviewed. Traditional media owners are also pressured by changing consumer behaviour. Of note, promotion levels are declining in the US although price increases are managing to pass through.

A number of companies spoke positively about European improvement, France in particular. Citi suspects, if Europe follows the US, the first quarter of 2016 could be a key one for advertising. In the US, traditional media benefited from early stages of the recovery and then reverted back to trend after a year as structural developments came to the fore. This is a factor the broker suggests should not be ignored in Europe. Mindful of these structural risks Citi takes a selective approach to Europe, preferring to play any recovery via those media owners where expectations are lower and/or valuations are not extreme.

Newspaper circulation data in Australia in the first quarter reveals a slowing of the decline in print. Citi notes this is now the sixth such quarter in a row. Despite this, declines are still double digit in some cases. The rate of decline was lower for Fairfax Media ((FXJ)) and Seven West Media ((SWM)) but up slightly for News Corp ((NWS)). The pace of digital subscription uptake has slowed.

Metro newspaper circulation is down 8.3% on a weighted average, the fourth consecutive quarter of single digit falls. Weekend editions performed slightly better than weekday editions. The reduced pace of circulation decline offers some hope but also raises further questions over the ability of newspapers to attract advertising in the long run, Citi maintains. The broker remains cautious about print publishers but rates News Corp a Buy, because of the digital and TV assets, and retains Neutral ratings for Fairfax and Seven West.

Household Solar

There is a large opportunity for household solar and batteries, in Morgan Stanley's view. From a survey of around 1,600 households in the National Electricity Market (NEM) the broker found a strong level of interest in such product, with a clear $10,000 price point and 10-year pay-back period. Around 1.1m households in the NEM already have solar panels which could be retrofitted with batteries. As yet, there are no clear winners in this market.

Morgan Stanley downgrades its utilities view to Cautious from In-Line. Australia's solar resource, high retail tariffs and early adopter culture means it is one of the forerunners in the global shift from centralised electricity. The broker expects debates round tariff structures, stranded assets and pool prices. Moreover, the broker estimates AGL Energy ((AGL)) and Origin Energy ((ORG)) could each witness earnings reductions of $30-40m in FY17, rising to $90-100m in FY20, absent a competitive response to this issue.

Early indications are that Tesla, the manufacturer of the PowerWall product expected to arrive in early 2016, will ignite the sector and this will lead to rapid take up of the batteries. What could go wrong? Morgan Stanley suspects Tesla may not be able to supply all Australian demand, potentially delaying take up. Technical issues, or a lower Australian dollar making the product more expensive, could also delay take up.

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