Brokers were particularly active on the down side of the ledger last week – 27 downgrades versus 12 upgrades – on the back of three major themes: resources stocks experiencing yet another downgrade cycle (investors will be hoping this is the final wash-out); the stand out performers that are believed to becoming too expensive; and finally knee-jerk responses to companies issuing profit downgrades.
On the upgrade side, the main theme appears to be that certain stocks have become too cheaply priced and yes, that also includes resources and mining services providers.
In the good books
[1]Bluescope Steel (BSL) was upgraded to Buy from Neutral by BA-Merrill Lynch. The broker said it sees plenty of upside from the falling AUD, noting every 1c drop adds $12 million to operating earnings. With nothing in the way of earnings expected in FY13, the news adds significant support to FY14 estimates and the valuation.
Iluka Resources (ILU) was upgraded to Outperform from Neutral by CIMB, and to Neutral from Underperform by Credit Suisse. Zircon appears to have turned the corner CIMB suggested, noting Iluka had increased sales by 143% in the first half over last year’s first half. Rutile and syn-rutile sales were weak, but, on a net basis, the broker lifted its forecast earnings by 56% and 31% for 2013-14. The earnings upgrades increased the target to $12.65 from $10.45, which lead to a rating upgrade.
The day before the update, Credit Suisse said it was concerned that zircon sales may have weakened. After strong demand was reported early in the second quarter, the broker said there have been no reports of price increases since early May. CS is concerned that easing housing sales in China, combined with falls in social financing, may be affecting demand and output.
BA-Merrill Lynch upgraded Pacific Brands (PBG) to Buy from Underperform. The broker increased its FY13 and FY14 earnings estimates by 9% and 18% respectively. The strategic direction of the company has been re-set and the broker said the strengths of the brands should now materialise. The past three to four years have been about cutting the cost base and opportunities now exist to grow sales through investment in key brands and acquisitions. Hence, the rating was upgraded to Buy and the price target raised to $1.05 from 40c.
Resmed (RMD) was upgraded to Outperform from Neutral by Macquarie. The broker reviewed its case for ResMed and while Macquarie admitted the risks around competitive bidding are not to be sneezed at, the ultimate impact will arrive much later than most expect and it probably won’t be as big as most fear. In the meantime, Macquarie said that operational and currency generated margin tailwinds, as well as strong end-user demand for sleep products, should continue to deliver positive earnings surprises.
In the not-so-good books
[2]Ansell (ANN) was downgraded to Underweight from Neutral by JP Morgan.
With the stock up 26% since the interim result and 20% above the price target, the recommendation was downgraded, largely on valuation grounds. The broker suspected that mixed production data, the inclusion of low quality property sales and a lacklustre performance from acquisitions, could force a reality check on investors that have bought into the macro theme.
Insurance Australia Group (IAG) was downgraded to Underweight from Neutral by JP Morgan. Given the sharp rally in recent weeks and the good result that is expected for FY13, JP Morgan moved the stock to Underweight. The price target was also reduced to $5.65 from $5.80. The broker said it does not believe Insurance Australia is as attractive on valuation grounds as it once was, trading at around 15 times FY14 earnings estimates on a dividend yield of 4.1% and with consensus margins at 13.5% for FY14 ahead of this update.
Leighton Holdings (LEI) was downgraded to Sell from Hold by Deutsche Bank. Deutsche Bank analysed Leighton’s revenue profile and opportunities for growth and said it expects revenue declines of 12% in FY13 and 9% in FY14. Revenue expectations were lowered for Australian infrastructure, contract mining, resources and Indonesian mining and Gulf construction markets. Revenue expectations for the Hong Kong/Macau and Indian markets were increased. As the conditions in most of the company’s markets remain challenging, the broker downgraded the recommendation, with the price target reduced to $16.56 from $20.86.
National Australia Bank (NAB) was downgraded to Neutral from Overweight by JP Morgan. Conditions are improving in the UK, which should be good for asset valuations. Nevertheless, JP Morgan noted the bank’s non-core commercial real estate (CRE) exposures reside elsewhere, where valuations have stalled at 15-25% below peak levels. In the case of regional shopping centres, this is as much as 35% below peak. A near-term surprise is not considered likely and the broker has downgraded the stock, prepared for a slow grind.
Qantas (QAN) was downgraded to Neutral from Outperform by Credit Suisse. Credit Suisse reviewed Australian domestic aviation and now has a preference for Virgin Australia (VAH) over Qantas, despite the fall in Qantas’ share price recently. The broker said it believes the integration of Tiger Australia and the rollout of Virgin’s three-brand strategy, will likely result in a far more efficient and highly segmented Australian corporate and leisure market.
Sandfire Resources (SFR) was downgraded to Sell from Buy by Citi, to Underweight from Neutral by JP Morgan and to Underperform from Neutral by Credit Suisse.
FY13 production was broadly in line with guidance, but Citi noted cash costs were higher than expected. FY14 guidance of 65-75kt was also below Citi’s previous estimates, which saw earnings forecasts downgraded.
June quarter production was largely as JP Morgan expected. Nevertheless, near-term production downgrades led to significant downgrades to FY14/15 earnings forecasts. The broker acknowledged Sandfire is one of the few resources companies that will generate positive cash flow on an all-in basis in FY14, but said it also believes the shares are expensive.
June quarter production was pretty much in line with Credit Suisse expectations as well. The big problem was that FY14 capex came in well above prior guidance, adding up to $82 million or more in FY15. The broker was expecting to see something like $25 million a year.
The FNArena database 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.
[3]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.
Also in the Switzer Super Report:
- Greg Fraser: Stocks in focus – Telstra [4]
- Peter Switzer: Stick to stocks [5]
- Penny Pryor: Power shift in SMSFs [6]
- Paul Rickard: FBT on cars – what the change really mean [7]
- James Dunn: Avoiding the traps in the stock market billabong [8]
- Penny Pryor: Another stellar week for Sydney property sales [9]