Weekly Broker Wrap: BHP, Cochlear upgraded, Leighton downgraded

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Weekly broker recommendation changes turned positive after six straight weeks of a negative weekly balance followed by the week before last’s neutral outcome. Last week upgrades outpaced downgrades fifteen to nine, with weaker AUD assumptions impacting heavily on the proceedings.

Cochlear (COH) featured prominently last week, picking up three separate upgrades to Neutral and one downgrade. Billabong also garnered an above average amount of attention, slapped with two downgrades for Sell. But it was Newcrest that had the toughest week, downgraded to Sell by three separate brokers.

Upgrades

BHP Billiton (BHP) upgraded to Buy from Underperform by BA-Merrill Lynch.

Forecasts were unchanged, but BA-Merrill Lynch lifted its price target by $6.00 and upgraded its recommendation. First, the broker thinks the 4% yield will help maintain a floor under the share price. Second, the broker also likes what it is hearing from the new CEO. With the new project moratorium drawing to a close, Merrills would like to see the Jansen Potash project greenlighted. It would cost between US$10-$15bn, but the upside would be worth it.

Billabong (BBG) upgraded to Neutral from Sell by UBS, downgraded to Underweight from Neutral by JP Morgan and downgraded to Sell from Hold by Deutsche Bank.

The Sycamore and Altamont consortiums have dropped their bids for Billabong. UBS assumes current balance sheet risk, little in the way of asset backing and a less than positive earnings outlook all contributed. The job for management now is to look for ways to cover the $400m that is due next July. It’ll either be divestments or a dilutive capital raising along with new debt and neither paints a pretty picture. The broker has cut its FY13-14 EPS forecasts by 34% and 42% on the above and lowered earnings guidance from management. The funding will be secured, says UBS, who had confidence enough to lift its call.

Deutsche Bank said another earnings downgrade and the cessation of takeover discussions means the company’s tight balance sheet has worsened. The broker believes there must be some value in the brands because of the continued interest in Billabong and the company’s dire need for capital may allow future suitors to enjoy some benefits without assuming the equity risk. The worst case is that no deal is agreed and the best case is that the consortia can cherry pick the best brands for a low price and offer debt financing with a coupon sufficient to compensate for their risk.

JP Morgan noted the focus for Billabong is debt refinancing and asset sales. The downgrade was based on a lack of earnings certainty and refinancing risk. The broker will revisit the stock once there is increased earnings and refinancing certainty.

Cochlear (COH) upgraded to Neutral from Underperform by Macquarie, to Hold from Sell by Deutsche Bank, to Neutral from Underweight by JP Morgan and downgraded to Underperform from Neutral by BA-Merrill Lynch.

Macquarie had feared Cochlear would not meet top-line expectations and this fear was borne out in the company’s downgrade to FY13 guidance. The broker also fears the trend could persist given the improvement in competitor products. Now the downgrade to earnings forecasts has happened the broker said consensus expectations are likely to end up at a more realistic level and, together with the launch of N6 and fading currency headwinds, the catalysts are more balanced.

Deutsche Bank noted Cochlear has historically enjoyed a sharp uplift in sales after a product launch and the broker expects this to occur again in FY14. Deutsche Bank is wary that the uplift will be more subdued, as market growth has slowed and competitors have launched products as well. Ultimately, the broker thinks the earnings benefit will be offset by reduced currency hedge gains as well. With the stock trading at a lower level now, room enough was seen for an upgrade.

JP Morgan upgraded its recommendation on the negative share price reaction post the company’s earnings downgrade.

BA-Merrill Lynchis now assuming that the global cochlear implant growth rate has slowed to around 5% over the past few years and with most of the kids now out of the way, adults have overtaken as the main recipients. Thus while the broker is still upbeat about the upside to come from technology progress and new clinic growth, this is being increasingly offset by near term earnings softness from the above mentioned slowing implant growth rate. FY13-14 EPS forecasts were trimmed by 2% and 9%, this pulled the price target lower, which in turn saw the recommendation downgraded.

Echo Entertainment Group (EGP) upgraded to Outperform from Underperform by Credit Suisse.

Credit Suisse said that equity markets are discounting the prospect that Echo entertainment will lose its Sydney exclusivity in 2019. To the broker, the stock is reflecting a 50% reduction in VIP turnover in 2020 and a 20% reduction in private gaming room revenue. Although the broker’s valuation is not based on this assumption, it noted were Echo to lose Sydney exclusivity the valuation would fall to around $2.60 a share. Credit Suisse is also not assuming the company will lose its monopoly position in Brisbane. The share price has fallen, hence the rating was upgraded.

Fantastic Holdings (FAN) upgraded to Outperform from Underperform by Credit Suisse.

The price target stayed put at $2.55 and EPS/DPS forecasts were unchanged, but Credit Suisse decided to upgrade its recommendation on unwarranted price weakness over the recently issued guidance and early signs of improvement in housing investment. Combined, these tell CS that we’re looking at an emerging counter cyclical opportunity. The broker sees the company getting off to a good start in FY14, with a tailwind from a gradual improvement in housing helping to support bulky goods sales, while CS also expects to see an improvement in consumer confidence and discretionary spending after the Federal election.

JB HiFi (JBH) upgraded to Buy from Neutral by UBS.

Forecasts and the $16.15 price target were maintained, but UBS decided to lift its recommendation, noting recent channel checks showed electronics retailing is not as soft as the apparel business, with sales solid and inventory levels clean. The broker also likes the look of the new JB Home format and noted trading so far has been surprisingly good. The better earnings outlook and recent underperformance in the share price were enough to spark the upgrade, UBS also liking the 5% yield.

Ramsay Healthcare (RHC) upgraded to Neutral from Underperform by CIMB.

CIMB updated currency forecasts and the broker also views the expansion efforts into Asia as favouring the upside from public-private partnerships.

Downgrades

Carsales.com (CRZ) downgraded to Sell from Neutral by UBS.

The broker said it likes the company and its dominant market position and continued to see plenty of upside. The problem UBS has is that most of the available upside is already in the price, with further market expectations looking increasingly unrealistic. FY13-16 EPS forecasts are pretty much unchanged and the broker lifted its long-term market share assumptions now that News’ (NWS) carsguide.com.au has not delivered on all the hype. The problem was that shares had outperformed the market by 56% over the last year and are looking really expensive. Couple that with overly optimistic market assumptions and you’ve got a downgrade despite UBS liking the fundamentals.

Leighton Holdings (LEI) downgraded to Sell from Neutral by Citi.

The broker noted the company has stopped work at the Senakin and Satui coal mines in Indonesia after a dispute about contract terms. On Citi’s numbers, the mines contribute up to 4% of group earnings. While the company and the broker think this will have a limited earnings impact, Citi did point out the growing evidence of the increasing earnings risks facing contract miners in Indonesia. Earnings forecasts were unchanged for the time being, but the price target was cut and the recommendation i downgraded. The lower price target was due to the broker now applying a 15% discount to its valuation to reflect Indonesian earnings risks. Senakin and Satui may only contribute 4% to group earnings, but the overall Indonesian mining contribution is somewhere closer to 15%.

Newcrest (NCM) downgraded to Sell from Neutral by Citi and UBS and downgraded to Underperform from Outperform by Credit Suisse.

Just like what we’ve been seeing from the likes of BHP Billiton (BHP) and Rio Tinto (RIO), Citi suspects a major strategic shift to less production, lower costs and more cashflow and higher shareholder returns is underway at Newcrest. Unlike the two majors, who are simply addressing market demand, Newcrest is also dealing with a falling gold price. All in all, Citi liked the plan, noting this is what investors want to see before confidence in the gold sector can build again. A higher gold price wouldn’t hurt either. The problem for Citi is that decreased production means lower revenue, which adds up to lower earnings and a lower valuation. Adding this into the mix caused Citi cut its call and slash its price target.

UBS added up the numbers and came to the conclusion that the recent guidance update for 5%-10% production growth in FY14 amounts to an 11% downgrade and is 15% short of consensus. Incorporating the lower production saw FY14 EPS cut by 32%. UBS warned there may be more cuts to come, as its numbers factor in a 1.02 AUD and gold at US$1625/oz.
Credit Suisse said it expects the plunge in the gold price will initially drive downgrades to price assumptions, earnings and valuations. Then there’ll be secondary downgrades to production as producers adjust plans so they can be sustainable in the event of an even more punitive gold price environment. At this stage, Credit Suisse said Newcrest’s challenge is to ensure net free cash generation at Lihir instead of growing production. Also the Kapit project is likely to be deferred if current gold prices continue.

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.

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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