Last week’s attempt to find a bottom in the Australian share market was solidly supported by stockbroking analysts issuing a tsunami of recommendation upgrades for beaten down ASX-listed stocks.
For the week ending Friday 23 November 2018, FNArena registered no less than 16 upgrades, of which four only went up to Neutral/Hold, against two lonely downgrades for Collins Foods and Wesfarmers. The latter was the sole recipient of a fresh Sell rating during the week, post Coles de-merger. The pain is compensated by the fact Wesfarmers also received one upgrade to Buy.
G8 Education was the only stock to receive two upgrades for the week; both went to Buy. Other recipients of new Buy ratings include ARB Corp, Carsales, Cochlear, Costa Group, Iluka Resources, Mineral Resources, and a2 Milk.
In relation to earnings forecasts, there were large increases for Mineral Resources, TechnologyOne, Sydney Airport, NRW Holdings, and CYBG. But there are equally large reductions on the flipside with Graincorp’s forecasts falling by -78%, followed by Viva Energy, Mayne Pharma, Baby Bunting, Ardent Leisure, and others.
The local out-of-season reporting season continues, while others are issuing shorter-term trading updates. Luckily, for Australian investors, not every market update implies the need for a downward correction, though it has to be pointed out, the underlying trend remains for weaker earnings estimates and lower valuations and stockbroker price targets.
The large gap between recommendation upgrades and downgrades by stockbroking analysts suggests many a share price might already be reflecting more than what seems justified at this stage.
In the good books
THE A2 MILK COMPANY LIMITED ((A2M)) was upgraded to Outperform from Neutral by Credit Suisse .B/H/S: 4/2/0
The company has indicated a solid start to the year, with revenue for the four months to October up 40.5%. Credit Suisse observes this is been driven by steady Australasian market share and progress on the Chinese infant formula business.
The company has also reaffirmed FY19 expectations. While the company’s execution impresses the broker, risks remain with Chinese regulation. However, with the stock having sold off -20% from late August, Credit Suisse believes investors are being more than appropriately compensated.
Rating is upgraded to Outperform from Neutral. Target is raised to NZ$12.25 from NZ$12.20.
ARB CORPORATION LIMITED ((ARB)) was upgraded to Buy from Neutral by Citi .B/H/S: 2/1/0
Last July saw the federal government ban gross combination mass (GCM) upgrades for new vehicles, meaning upgrades to vehicle weight/towing capacity, which ARB provides. Queensland has extended that ban to all vehicles. Citi believes the negative impact on ARB has been overdone by the market, given gross vehicle mass (GVM) upgrades on new vehicles are still permitted and GCM upgrades on used vehicles are still permitted in most states.
Share price weakness has taken ARB to a below average premium to the small industrials hence Citi upgrades to Buy from Neutral. Because ARB did not have products available in a timely manner for the new Hilux and Ranger releases, earnings trimmed and target falls to $19.58 from $22.35.
COSTA GROUP HOLDINGS LIMITED ((CGC)) was upgraded to Outperform from Neutral by Macquarie .B/H/S: 2/2/0
Macquarie believes the company is off to a solid start in FY19, as it has reiterated guidance for low double-digit growth. There is a significant 84% skew to the second half for net profit, the broker calculates.
Regardless, the company has a strong market position in attractive categories and a good track record of execution on growth projects.
Macquarie upgrades to Outperform from Neutral. Target is reduced to $7.60 from $8.15 because of changes on the back of higher long-term capital expenditure assumptions.
COCHLEAR LIMITED ((COH)) was upgraded to Overweight from Equal-weight by Morgan Stanley .B/H/S: 2/3/2
Morgan Stanley estimates the current developed market penetration for Cochlear is around 5% and the capture of the annual incidence of severe hearing impairment is only 7%. The low penetration is explained by the weak relationship between hearing aid and cochlear implant audiology channels.
The broker believes Sycle will bridge this channel and sustain long-term market growth. Sycle is audiology practice management software used by around 7000 hearing aid clinics across the US, UK and Canada. This should increase the awareness of cochlear implants in retail channels by facilitating diagnosis of candidates.
Morgan Stanley suggests the valuation of this market-leading stock with life changing technologies has become more attractive. Rating is upgraded to Overweight from Equal-weight. In-Line industry view. Target is $175.
MINERAL RESOURCES LIMITED ((MIN)) was upgraded to Buy from Hold by Deutsche Bank .B/H/S: 3/0/0
Albemarle will pay US$1.15bn to buy a 50% stake in a joint venture in the Wodgina hard rock lithium mine. Deutsche Bank notes Mineral Resources initially wanted to sell just 49% in order to have control of the asset.
Albemarle has stated it aims to produce at least 100,000tpa which suggests it may desire to replicate the design of its Kemerton facility. Either way, Deutsche Bank believes the company’s experience in the industry will help develop and market the product.
The broker takes a conservative stance on the downstream asset potential, which is new for Australia, and believes there are implications for spodumene, hydroxide and the lithium market structure with this deal. Rating is upgraded to Buy from Hold. Target is $18.50.
SONIC HEALTHCARE LIMITED ((SHL)) was upgraded to Neutral from Underperform by Credit Suisse .B/H/S: 3/5/0
Credit Suisse observes, since the FY18 result, the stock has underperformed the market. Guidance has been reaffirmed for 3-5% growth in operating earnings, weighted to the second half.
While remaining cautious on the operating environment, particularly given softer Australian pathology volumes and regulatory headwinds in the US and Germany, the broker believes risks are now factored in.
Rating is upgraded to Neutral from Underperform. Target is reduced to $23.00 from $23.50.
WEBJET LIMITED ((WEB)) was upgraded to Outperform from Neutral by Credit Suisse .B/H/S: 3/2/0
After the strong FY18 result and even stronger run up in the share price, Credit Suisse believed Webjet was fully priced and downgraded to Neutral. Since then, the stock has materially underperformed and Webjet has also acquired Destinations of the World.
The trading update for FY19 has confirmed momentum is strong and the growth outlook attractive, hence Credit Suisse moves the rating back to Outperform. Target is reduced to $14.40 from $16.00.
WESFARMERS LIMITED ((WES)) was upgraded to Outperform from Neutral by Credit Suisse .B/H/S: 2/3/2
Credit Suisse is well aware of the slowdown in housing-related demand but believes the market is underestimating the opportunity for of value creation in the company’s industrials business.
The recent contract between Woodside ((WPL)) and Perdaman highlights WA gas pricing is at a level where domestic downstream investment can be supported. Given existing infrastructure at Kwinana and a site at Burrup, Credit Suisse is surprised Wesfarmers was not party to that deal.
As for Bunnings, the broker expects growth from expanded ranges and online penetration and there is some buffer given the high exposure to the do-it-yourself market.
The broker also sticks its neck out, suggesting that over the next two years there will be significant expansion of Wesfarmers’ ammonia manufacturing, while Blackwood’s earnings should double over the next five years.
Rating is upgraded to Outperform from Neutral. Target is reduced to $34.07 from $49.47.
See also WES downgrade.
In the not-so-good books
WESFARMERS LIMITED ((WES)) was downgraded to Sell from Neutral by Citi .B/H/S: 2/3/2
In the wake of the Coles ((COL)) de-merger and the prior divestment of loss-making and/or capital intensive businesses, Wesfarmers is now around 60% exposed to Australian housing, via Bunnings and Kmart, Citi notes. There is little in the way of organic growth in the offing so the challenge will be to use the now well-stuffed balance sheet for diversification acquisitions.
If none present, a capital return might be the option. Until more is clear, Citi prefers the two supermarkets. Downgrade to Sell from Neutral. Target falls to $29.20 from $45.30 ex-Coles.
See also WES upgrade.
Earnings forecasts
Listed below are the companies that have had their forecast current year earnings raised or lowered by the brokers last week. The qualification is that the stock must be covered by at least two brokers. The table shows the previous forecast on an earnings per share basis, the new forecast, and the percentage change.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.