Analysts see green light for market

Why most equity analysts think the Australian sharemarket will rise further in 2014.

Summary: The outlook for the Australian sharemarket remains strong, with a majority of leading equity strategists tipping the market will continue to rise over the course of this year. Behind their forecasts are an array of factors, including increased M&A activity, an improving economic environment, and more share buybacks and IPOs.
Key take-out: The energy sector is generally seen as being hot, and companies exposed to the United States are expected to do well, especially if our dollar declines. But a lower $A is not necessarily a given.
Key beneficiaries: General investors. Category: Shares.

Some of Australia’s most highly regarded equity strategists have delivered their outlook for the sharemarket going into 2014-15 – and it appears to be more good news for investors.

Despite shares already returning more than 19% to investors over the past 12 months (see A big financial year for shares), sharemarket strategists agree that more gains are in store, with three out of five estimating the S&P/ASX 200 index to at least reach 5,700 by year’s end. It closed today at 5,518.9.

Increasing corporate activity in the form of mergers and acquisitions (M&A), share buybacks and initial public offerings, as well as an improving environment in developed markets, are expected to drive the share market higher over the next six months – offsetting a potentially mixed earnings season come August.

Indeed, just today Expedia Group lobbed a $703 million takeover bid for online travel booking services company Wotif.com, valuing the company at $3.30 a share.

But it’s the energy sector which is a hot favourite to outperform over the next 12 months, followed by companies exposed to the rebounding US economy and the potential for the Australian dollar to weaken like insurer QBE Insurance (QBE) and container solutions company Brambles (BXB).

Hasan Tevfik, Credit Suisse

Investors should enjoy a total return of 17% this calendar year, says Hasan Tevfik, Australian equity strategist at Credit Suisse.

Considering the S&P/ASX 200 index has only returned a little over 6% to investors so far, that’s an optimistic outlook for the next six months. Indeed, Credit Suisse has raised its December target for the index to 6,000 points from 5,600 points.

The major reason why Tevfik has boosted his forecast is the belief the number of shares on issue in the Australian equity market will shrink this year as merger and acquisition activity heats up and companies prefer to finance themselves through low-cost debt rather than equity.

As shown in the graph below, our local market hasn’t seen such a year of ‘de-equitisation’ since 2005. This is in contrast to the US and Europe markets, where the share count has been relatively flat over the same period.

Meanwhile, Tevfik says demand for Australian shares will remain high – particularly from self-managed super funds (see SMSFs become a distorting force).

Tevfik recommends several strategies for the second half of the year. Not only should investors buy equities in general, but they should also search for takeover targets, as well as companies making earnings-per-share (EPS) accretive acquisitions and companies engaging in EPS accretive buybacks.

One company which appeals to Tevfik as a takeover target is Myer (MYR). With David Jones (DJS) likely to be taken off the share register, Myer becomes the only listed department store on the ASX. Further, it trades at a 40-50% discount to its global peers with an expected yield of 7% for 2014-15.

Credit Suisse has also flagged Telstra (TLS) as a good opportunity as it believes the company plans on announcing a $2 billion buyback at its 2013-14 results.

In contrast, companies that issue equity should be avoided as they will be left behind, Tevfik says. Credit Suisse has an underweight on Origin Energy, given it recently issued equity to fund the purchase of natural gas prospects in the Browse Basin.

Paul Brunker, JP Morgan

Paul Brunker, managing director of research at JP Morgan Australia, forecasts the Australian equity market to meander up to 5,700 by December as the rally in yield stocks comes to an end.

While Brunker doesn’t anticipate a sharp correction in the share prices of the banks, telcos or real-estate investment trusts (REITs), he thinks they will run out of road due to waning valuation support and micro-economic issues.

The banks – which Brunker says have become ‘honorary defensives’ in the absence of truly defensive sectors in Australia – face growing competitive pressure, particularly in mortgages where second tier lenders exploit lower funding costs and recovering securitisation markets.

Unlike Tevfik, Brunker doesn’t think Australian companies will retire equity through buybacks and M&A for several reasons: their payout ratios are too high, limiting their balance sheet capability; the Australian market is too concentrated already; and we don’t have the global industries which appeal to overseas acquirers.

On the other hand, the Australian market will get a boost from stronger developed world growth and a weaker Australian dollar, says Brunker. As the US economy improves and macroeconomic trends become more favourable to the US dollar, Brunker expects the Australian dollar to drift lower throughout the new financial year.

Given the macro-economic factors, JP Morgan sees energy as being the most attractive sector going into the next 12 months, with Santos (STO) and WorleyParsons (WOR) among its overweight positions.

Companies set to benefit from growth in developed markets without the commodity exposure include QBE Insurance, Brambles and Bluescope Steel (BSL), says Brunker.

Lastly, Brunker expects the mining sector to lift slightly over the course of the year, factoring in volatility for the iron ore price and modestly positive steel production in China. However, investor skittishness over data from China will cap the potential for greater gains.

Tim Rocks, Commonwealth Bank

But not all the analysts are optimistic about the Australian equities market for 2014-15. Tim Rocks, equity strategist at Commonwealth Bank, forecasts the S&P/ASX 200 index to fall to 5,000 points by the end of December.

Valuations in the industrials market are getting scary at around 18 times amid what is a progressively worse earnings environment compared to 2013-14, says Rocks.

“Analysts are forecasting 12% growth for next year and that just won’t happen,” says Rock. “A number closer to zero would be a better starting point.”

Lower growth factors for Rocks include the housing construction market already close to peaking, infrastructure investment not arriving until 2015-16, the impact on resources stocks (particularly iron ore miners) from the impending hard landing of the Chinese economy and the high Australian dollar.

Commonwealth Bank recently lifted its forecast for the Australian dollar after the US Federal Reserve pushed out its rate call. It now anticipates the local currency to climb to US99 cents by March next year.

While Rocks agrees with Tevfik that Australia should experience a shrinking share count for 2014-15 from more corporate activity, he thinks any gains will be more than outweighed by the negative drip-feed of earnings news, both from results season and when companies host AGMs near the end of the year.

Mining and mining services stocks should underperform the market, along with those exposed to housing, says Rocks.

Rocks looks for stocks that he thinks will be defensive enough to weather the fall in the wider index. Given he believes even more excess liquidity will pour into the market as the European Central Bank starts quantitative easing, he thinks the high-yielding stocks, including the banks and Telstra, will continue to hold ground.

“As a sign of defeat the biggest overweight in my portfolio is Telstra,” says Rock. “That’s genuine: its growing its dividends again as well as its customer base, which is underestimated by the market.”

Rocks also likes ANZ, ResMed, Insurance Australia Group and Spark Infrastructure.

Tim Baker, Deutsche Bank

The best strategy for investors right now is to buy into some of the defensive sectors, says Tim Baker, head of equity strategy at Deutsche Bank.

While Baker also reached an estimate of 5,700 points for the S&P/ASX 200 index by the end of December this year, it was revised down from his previous forecast of 6,000 points on the back of softening commodity prices and the stronger Australian dollar.

Together with poor consumer sentiment, these factors point to a greater likelihood of EPS downgrades in the near future, says Baker. Only 37% of companies have had their earnings revised upwards in the past month, down from 47% in the year to date.

The biggest drag on revisions is the cyclical sector – despite their recent popularity among other analysts – and Baker says they are set to sink further.

Among the defensives, Baker dislikes consumer staples and telcos because they look too expensive, while utilities appear to be the cheapest option.

Gas and electricity distributor AGL Energy, QBE Insurance, Primary Healthcare and Telstra are Baker’s top five picks for defensives, when screening for factors including a low forward price-earnings multiple, EPS growth and their dividend yields in the next 12 months.

Like JP Morgan and JB Were, Deutsche Bank is also overweight on the energy sector. LNG projects are coming online and the oil price is holding up well thanks to rising demand and ongoing supply concerns, Baker says.

James Wright, JBWere

Companies with offshore earnings are likely to issue earnings downgrades in the full-year results season, says James Wright, chief investment officer at JBWere.

While Wright thinks the Australian dollar is likely to trend lower throughout the year, its relatively high level so far has already caused moderate damage in the first half of 2014.

The consumer discretionary sector could also face further downgrades, Wright says, given the fallout from the federal budget and the late start to winter. The list of profit warnings so far includes The Reject Shop, Flight Centre, Pacific Brands and Super Retail Group.

Wright doesn’t offer an index forecast or buy calls for specific stocks for 2014-15, but he agrees with Brunker that the energy sector will perform strongly, with several large projects – such as Oil Search’s PNG LNG project – coming into production and generating strong cash flows.

The Australian dollar should weaken as well, providing relief to exporters and companies competing with imported goods and services, says Wright.

In an environment of low earnings expectations and high price-earnings multiples, Wright anticipates more corporate activity from M&A and more initial public offerings. Despite patchy performances from new floats so far this year, the pipeline remains strong and he expects a large number of listings for the next six months.

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