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Weekly Broker Wrap: Oz Earnings Deliver On Modest Expectations

Reported by FN Arena
Monday, March 4, 2013
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-Overall earnings positive -Expectations modest -Banks, staples the best performers -Resources, REITs, the worst  

By Eva Brocklehurst

Earnings season hasn't been so bad. The overall impression has been positive enough to keep the market firmly on the rise over February. UBS notes, sector-wise, the strongest performances over the month have been from banks, insurance, retailing and consumer staples while the weakest performances have been in resources, real estate investment trusts and infrastructure.

In aggregate, consensus FY13 and FY14 earnings estimates have been upgraded slightly and UBS believes, in the current environment, this should be interpreted as a good result. Additionally, this is the first time since early 2011 that the Australian market aggregate earnings have been upgraded. OK, so there were some low expectations for the likes of  JB Hi-Fi , Bradken , Leighton Holdings , Stockland , Downer EDI , BlueScope , Toll Holdings , Qantas , Transpacific and Harvey Norman . These all managed to surprise to the upside.

Banks fared the best. Both the Commonwealth Bank and National Australia Bank delivered favourable trading updates while regional Bendigo and Adelaide Bank had an improved result. Better debt markets have translated to improved deposit pricing for the banks and JP Morgan expects this will help profitability in the longer term. The broker has upgraded forecasts for FY14 by around 2% and for FY15 by around 4% and put NAB at the top of its pick list with a Buy rating.

On the other side the regionals, BEN and Bank of Queensland , are now rated Sell. Why? Regional banks have outperformed the banking index by 5% since October and these two are now on the same yield as their big brothers. Hence, JP Morgan finds limited potential for ongoing strength. Joining JP Morgan on the FNArena database and echoing the Sell sentiment for BEN is CIMB. The six others rating the stock have a Hold. For BOQ it's a little different as the bank won't report interim results for a couple of months. JP Morgan is the only Sell rating. The others consist of four Hold and three Buy ratings.

The results in the building materials sector were mixed. Deutsche Bank noted Australian construction demand remains under pressure but there are some bright spots. The US housing industry is picking up well and should continue to do so, while price increases have been achieved. DB analysts expect Australian housing starts will start recovering in the June quarter, particularly in NSW, Queensland and Western Australia, offsetting weakness in Victoria. The broker's pick of the sector is Fletcher Building as the NZ recovery is underway and the stock offers good leverage to the Australian market. Joining Deutsche Bank with a Buy rating on this stock are three others on the database. There are four Holds and one Sell.

Macquarie flagged earnings risk this season for WorleyParsons , United Group and Transfield and this was confirmed. Among the contractor sector there were hits and misses. DOW and LEI stood out for this broker in terms of the upside surprise. DOW announced its first dividend in two years and LEI impressed with better-than-expected cash flow and gearing. The slowdown in the resources sector is affecting some contractors more than others and Monadelphous is the case in point. The company suspects revenue growth in FY14 will be a struggle. Macquarie's picks in this sector include DOW and WOR. DOW is considered relatively cheap while WOR has a positive in its North American exposure. Others in the sector, such as Boart Longyear , have probably experienced the bottom of the earnings cycle, according to the broker, while Transfield's cost cutting should allow growth in FY14.

The steel sector delivered the cost cutting that was expected. Deutsche Bank thinks this should stand Sims Metal ,  Bluescope and Arrium in good stead in the second half. BSL is the broker's pick for the sector. There is significant valuation upside there with cost cutting, benefits from anti-dumping and a strong balance sheet after the closure of the Nippon JV. Key risks for the steel sector are ongoing Australian dollar strength, softer steel and scrap prices and an increase in imports. For ARI, Deutsche Bank has a Hold recommendation and is joined on the database by Credit Suisse. There are two Buys and one Sell. The Sell recommendation is BA-Merrill Lynch which finds, iron ore earnings aside, ARI is expensive.

Top pick for Morgan Stanley in the health care sector is ResMed . The broker believes this stock has the greatest upside potential. The value is in robust growth rates and market penetration. The dominance of mask sales as a percentage of US revenue supports gross margin in the wake of a strong Australian dollar. Primary Health Care is the second in line, as falling capital expenditure and greater efficiencies from existing GPs drive improving returns. Morgan Stanley likes CSL and Ramsay Healthcare in terms of  greatest earnings certainty. Sigma Pharmaceutical's outlook, in this broker's view, is clouded by patent expiries and price disclosure issues. Morgan Stanley believes Sigma is fully valued, admittedly with a 6% yield. Cochlear has the greatest uncertainty because of potential erosion of market share. This is Morgan Stanley's one Sell recommendation in this sector. It's not alone. Those rating the stock on the FNArena database include six with Sell ratings and just two with Hold.

After all that optimism it's time to sober up. The market has rallied 20% over the last six months and valuations are back near long-run averages. UBS expects earnings growth will need to ratchet higher to justify current valuations. The broker expects 3% earnings growth for FY13, or 7% if you leave out resources, and 7% top-down earnings growth in FY14. Small upgrades to FY13 and FY14 estimates reveal more realistic assessments, improving commodity and asset markets and better focus on costs. Moreover, there is no need for big upgrades to estimates, the broker contends, it's simply sufficient that the downgrades ease off. This will allow modest gains to be had over the next year. In the short term, nonetheless, the market is looking overbought.

 Based on a combination of share price reactions, UBS analysts have highlighted the most well received large cap results: DOW, RMD, IAG , AGL Energy , TOL and HVN. The most disappointing: Sonic Healthcare , COH, Ansell , Aurizon and UGL. The most well received small cap results: JBH, TPI and BKN. Most disappointing: Breville , SAI Global and BLY.  

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28/08/2014 13:05Sydney, Australia. 28 August,2014
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