Weekly Broker Wrap: Oz Equities, Retailers, Small Caps And Wagering

This story features HARVEY NORMAN HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: HVN

-Cyclicals more interesting for UBS
-Citi cites 3 retailers losing share
-Citi's top small caps
-DB considers high PE stocks cheap
-New small caps on Bell's radar
-MS picks key wagering performers
 

By Eva Brocklehurst

Does the Australian equity market have a growth problem? This is the question UBS asks, given earnings growth in aggregate has struggled over the last few years. FY15 too looks like being another soft year. While consensus estimates centre on growth around 6%, UBS has a top-down estimate of 2-3%. Lower commodity prices could aggravate this further and the broker suspects growth could easily slip into negative.

Admittedly, if the troubled resources sector is removed, the trends are better, as is share price performance. Even so, the broker envisages risk is moderately to the downside. The market is nearing fair value and, while the broker envisages there is still more to be gained in the energy sector, the exposure to a lower Australian dollar through cyclical stocks makes these more interesting than defensives. UBS tweezes out some value in some of the domestic cyclicals, favouring Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)).

After analysing market share movements across Australian retailing, Citi has noted an interesting development. Previous winners are now losing market share, raising the prospect of margin pressure as they seek to address this loss. The broker believes Woolworths ((WOW)), Harvey Norman and JB Hi-Fi are most at risk and has Sell ratings for all three, noting the Christmas trading quarter will be crucial. Removal of petrol discounts on January 1, 2014, is partly to blame for Woolworths losing 90 basis points of market share over 2014 but Citi estimates around half the losses relate to Aldi and Costco.

In electronics, JB Hi-Fi has lost share for the first time but has said it will protect perceptions that it is competitive. In Citi's opinion, the only plausible outcome from this strategy is lower gross margins. Meanwhile, Harvey Norman's market share continues to slide, even with its furniture division and exposure to housing. In this case, the broker notes the store appears less inclined to reduce gross margins.

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Citi's top calls among small cap industrial stocks include Buy rated AWE ((AWE)), Charter Hall ((CHC)), Flexigroup ((FXL)), iiNet ((IIN)), Karoon Gas ((KAR)), McMillan Shakespeare ((MMS)), Nine Entertainment ((NEC)), Spotless ((SPO)) and Veda ((VED)). AWE trades at a discount to fair value on the broker's calculations while Flexigroup, Charter Hall and iiNet all appear well placed in their respective sectors. Karoon Gas has an active on-market buy-back in place, which signals to Citi the company is confident about results from its Brazilian drilling program. For McMillan Shakespeare business is back to normal while Nine has the potential for earnings growth, with or without the impact of the advertising cycle. Spotless is expected to close the valuation gap to its peers, while Veda is considered to have a solid track record of growth.

The top Sell call is G8 Education ((GEM)), as the broker considers there are headwinds which are not appropriately priced in. In resources, the key Buy calls are Regis Resources ((RRL)), Resolute Mining ((RSG)) and Western Areas ((WSA)) with Regis Resources now returning to form all are considered reliable producers and performers. The top Sell is Paladin Energy ((PDN)). Citi expects a funding shortfall when the November 2015 convertible bond is due.

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With the market bouncing back from the September sell off the message Deutsche Bank receives is that the 12 month forward price/earnings ratio (PE) is back above the average. To the broker this appears sustainable in a world with persistently low interest rates. The earnings revision ratio is only a little below average while FY15 earnings growth forecasts are sliding just a little.

High PE stocks appear cheap and the broker rates several as a Buy, including Iluka Resources ((ILU)), Alumina ((AWC)), Seek ((SEK)), Carsales.com ((CRZ)), CSL ((CSL)), Aristocrat Leisure ((ALL)), James Hardie ((JHX)), Tabcorp ((TAH)) and Brambles ((BXB)). The broker notes offshore cyclicals and banks are popular with analysts, while energy is viewed more neutrally now after being unpopular mid year. Australia continues to offer dividend appeal with its PE high versus Asian peers. Small caps are subdued, Deutsche Bank observes, and this has brought the small industrial valuations back to levels in line with historical averages. 

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SeaLink Travel ((SLK)) offers leverage to growth in international visitors, particularly from Asia, and Bell Potter has initiated on the stock with a Buy rating. The company operates cruise and charter services on Sydney harbour through Captain Cook Cruises and Bell Potter estimates that around 40% of passenger numbers are derived internationally in this division. The company currently obtains the bulk of revenue from passenger, freight and services to Kangaroo Island, where 20% of passenger numbers are also sourced internationally. The servicing airport, Adelaide, has the largest growth in international passenger numbers of all the domestic airports in FY14, with the bulk of this growth from Asia.

The broker also likes nearmap ((NEA)), also initiating coverage with a Buy rating. Nearmap has developed a unique process for capturing, processing and publishing images, which should deliver a much superior product to the traditional process. Bell Potter believes nearmap can generate strong earnings growth and, as its cost base is largely fixed, there is significant operating leverage.

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Morgan Stanley expects Tabcorp, Sportsbet and William Hill will emerge as the long-term winners in Australia's online wagering market. Together, these three control nearly 80% market share and are expected to consolidate this share, because of their innovations in mobile and expansion of product offering. Race field fees are still expected to rise but Morgan Stanley differs with consensus in that it does not assume increases will be in measured increments. The broker remains cautious about Tatts ((TTS)), until evidence emerges it has successfully re-branded its wagering division. 
 

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