Last week there were twice as many rating downgrades being issued as upgrades, but this shouldn’t surprise as major indices in Australia hit six-year highs during the week. History shows there’s usually a direct correlation between rising share prices and rating downgrades, as apparent valuation shrinks with higher price levels.
On the positive side of the ledger, we find companies such as Genworth Mortgage Insurance Australia and Insurance Australia Group; companies that issued well-received market updates. But admittedly, the overall picture last week leans more to the negative.
In the good books
Aurizon Holdings (AZJ) was upgraded to Buy from Neutral by UBS. Aurizon has traded back to Dec 2013 levels despite general strength in infrastructure stocks, recent coal price recovery and evidence of cost reduction momentum. The market has been concerned over the drag from its potential west Pilbara investment, but the broker sees it as an opportunity to recycle capital out of Queensland coal into higher returning WA iron ore without jeopardising dividends.
Evolution Mining (EVN) was upgraded to Neutral from Underperform by Credit Suisse. Credit Suisse notes the FY15 production and cost outlook are similar to FY14. Mt Carlton started in FY14 while Cracow was strong and Mt Rawdon stable. The weaker performers were Edna May and Pajingo, which were beset by grade and reliability issues.
Regis Resources (RRL) was upgraded to Outperform from Neutral by Macquarie. Regis Resources’ quarterly suggests production is showing signs of recovery, the broker notes, but impairments will be taken on Duketon and McPhillamys and write-downs to Garden Well and Rosemont. The broker suggests expectations have now been reset and material issues affecting Duketon have been worked through.
In the not-so-good books
Alumina (AWC) was downgraded to Underweight from Neutral by JP Morgan. Alumina has been one of the best performing stocks in the mining sector this year but JP Morgan notes margins in the AWAC business have fallen. The broker recognises a lack of identifiable catalysts to drive a share price de-rating but considers an Underweight recommendation, reduced from Neutral, is now justified, based on stretched metrics versus mining sector peers.
Boart Longyear (BLY) was downgraded to underweight from Neutral by JP Morgan and to Sell from Neutral by Citi. The June quarter update highlights the continued pressure on the business from persistent weakness in global mineral exploration and a stretched balance sheet. JP Morgan believes these factors raise the risks for investors from a highly diluting recapitalisation and this is not reflected in the share price. Earnings are a little shy of Citi’s forecasts. The broker thinks operating metrics suggest demand has reached its low point but assumes a gradual upturn in profitability.
Cochlear (COH) was downgraded to Underweight from Neutral by JP Morgan. In previewing Cochlear’s FY14 result, JP Morgan assesses the stock is now trading on a price/earnings of around 32 times FY14 expectations and, despite factoring a rebound in volumes, FY15 remains high at 25 times. With potential downside to the target – raised to $56.72 from $55.76 – the broker downgrades on valuation grounds, recognising the risk around low quality earnings when the stock is priced to perfection.
Independence Group (IGO) was downgraded to Neutral from Buy by Citi. Production was ahead of guidance in FY14 and the pre-released financials show weaker profits because of write-downs. Earnings were in line with the broker’s estimates. Citi is downgrading to Neutral from Buy because of the strong performance in the share price recently.
Leighton Holdings (LEI) was downgraded to Sell from Neutral by UBS. Leighton’s profit beat the broker’s forecast but D&A, tax and other factors masked a miss on underlying earnings. Full year guidance was reiterated but cash flow was weak and gearing remains above target.
Monadelphous (MND) was downgraded to Sell from Hold by Deutsche Bank. The changes reflect a weak outlook for engineering construction in the resources sector, with the broker’s analysis suggesting there are few large construction projects for the company to work on.
SEEK (SEK) was downgraded to Underperform from Neutral by BA-Merrill Lynch. The broker is downgrading to Underperform from Neutral, citing a subdued Australian employment outlook and education earnings set to peak in FY16 as Swinburne matures. Meanwhile, competition is also holding back growth at Zhaopin and there is regulatory risk from Singapore on the Jobstreet acquisition.
Earnings Forecast
FNArena tabulates the views of eight major Australian and international stock brokers: BA-Merrill Lynch, CIMB, Citi, Credit Suisse, Deutsche Bank, JP Morgan, Macquarie and UBS.
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 regards to your circumstances.
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Also in the Switzer Super Report:
- Peter Switzer: How to deal with the Dirty Harry problem [2]
- Paul Rickard: Market on a high – portfolios up in July [3]
- James Dunn: Earning season preview, Rio, News, and Cochlear [4]
- Penny Pryor: Shortlisted – resources and Resmed [5]
- Staff Reporter: National clearance rate approached 70% [6]