Morningstar Equities Research

Morningstar Equities Research - MMS, GMA, AOG, TME-NZ, TME, BWP, GOZ, TGA, REA, TWE, FXJ, ABC and QBE, EHL on price change

McMillan Shakespeare Limited MMS| Short-Term Regulatory Risk Subsides as McMillan Shakespeare Escapes the Budget Unscathed
Morningstar Recommendation: Hold
Daniel Mueller, Morningstar Analyst - 02 9276 4419
The implications of the federal budget appear benign for McMillan Shakespeare. There were no proposed changes to tax legislation that would materially impact McMillan's salary packaging or novated leasing businesses. The increase in the Fringe Benefits Tax, or FBT, will match increases in personal income tax rates, effectively a neutral outcome that maintains the current tax benefit. The company also provided an update on novated lease orders to the end of April, with strong momentum since the federal election continuing. Since the previous update to the end of January, orders for the last three months have grown 15% on the previous comparable period.

We make no changes to our net profit after tax, or NPAT, forecasts and we maintain our expectation that fiscal 2015 will be a very strong year, with 34% NPAT growth, following the one-off disruptions to the business in fiscal 2014. Our fair value estimate remains AUD 11.00, with the shares currently trading in line with our assessment of fair value. We continue to rate McMillan as having no economic moat.

Despite the lack of adverse proposals in the federal budget and a current federal government that appears comfortable with the existing FBT framework, we view regulatory risk as a long-term overhang because most of McMillan's earnings are driven by tax concessions. Despite being the largest salary packaging company in Australia, we do not view its size as a sustainable competitive advantage. The industry has low entry barriers and high returns on capital, which could conceivably attract well-capitalised competitors over the long-term. The more capital intensive asset management division, which provides fleet leases and management, operates in a competitive industry with low pricing power against global behemoths such as GE Capital and Toyota Finance.

Genworth Mortgage Insurance Australia Limited GMA| Genworth Australia's Strong Fundamentals Compensate for Higher Risk
Morningstar Recommendation: Accumulate
Nathan Zaia, Morningstar Analyst - 02 9276 4491
Genworth Australia successfully listed on the Australian Securities Exchange on 20 May 2014 after the U.S.-based parent, Genworth Financial Inc. (NYSE: GNW), sold down its stake to about 66%. Strong demand saw the issue oversubscribed and priced attractively at AUD 2.65 per share, above the mid-point of the indicative pricing range of AUD 2.20 to AUD 2.90 for the 220 million shares sold. The earnings outlook is positive for Australia's largest mortgage insurer and we take comfort from the long and profitable track record. The stock will likely attract income investors because of large, fully franked dividends based on a sustainable 50% to 70% payout, though the firm is higher risk than typical income stocks. Our fair value estimate of AUD 3.50 per share equates to a forward price/earnings multiple of 10 times and 0.9 times book value. At current prices the stock is undervalued, trading 15% below our valuation on a forward price/earnings multiple of just 8.5 times.

Despite Genworth Australia's track record of strong underwriting profits, we consider the business does not benefit from an economic moat, reflecting the concentrated and powerful customer base, strict regulatory capital requirements and the potential for volatile earnings. Returns on equity, or ROE, remain consistently below the 11% estimated cost of equity. Current ROEs are about 10% despite a robust Australian housing market and benign claims. Genworth's moat trend is stable. Despite a tough competitive environment, we do not expect the company's competitive position to weaken any time soon as customers need mortgage insurance to manage credit risk on their massive home loan portfolios. Genworth Australia is assigned a high fair value uncertainty rating. While it has a strong balance sheet with capital well above minimum prudential requirements, it is highly leveraged to the economic cycle and, more specifically, the Australian housing market. We rate stewardship of shareholder capital as Standard.

Aveo Group AOG| Two New Sites Will Help Aveo Hit Development Targets
Morningstar Recommendation: Accumulate
Tony Sherlock, Morningstar Analyst - 02 9276 4584
Aveo used the proceeds from the disposal of its 50% share of a joint venture with Mulpha Group to acquire to two retirement development sites for AUD 53.6 million. One is part of the Norwest Business Park at Baulkham Hills in Sydney's northwest. The other is at Sanctuary Cove, Queensland. Mulpha is the vendor of both sites, reflecting the close relationship between the two, with Mulpha owning 22.6% of Aveo.

Aveo expects to develop 740 retirement units or aged care beds on the two sites from fiscal 2017, estimating an end value of AUD 380 million. The acquisitions form part of Aveo's strategy to sell 500 annually by fiscal 2018. We expect strong demand for the units at Sanctuary Cove due to its warm location and proximity to the Gold Coast.

We expect further sites will need to be acquired for Aveo to achieve its targets for new development units. We forecast Aveo develops 133 new units in fiscal 2016 and 340 units in fiscal 2018, with significant earnings upside if it achieves its delivery objectives. We don’t believe the business is currently set up to achieve the delivery targets as the retirement market is shallow and a broad reach is required to secure 500 new retirement commitments annually. Aveo has been able to sell around 500 units annually of residential stock, but the peak level of new retirement stock it has been able to sell was 67 units in fiscal 2010.

We make minor revisions to our earnings forecasts for this no moat-rated firm, with our fair value estimate unchanged at AUD 2.40. Aveo's shares are considered undervalued at current trading levels, with the key earnings catalysts being progress on divestment of AUD 216 million of commercial property and sale of the AUD 115 million of apartment developments underway.

Trade Me Group Limited TME-NZ| Fair Value Cut For Trade Me on Lower Revenue and Margins, Classifieds Outlook Not so Rosy
Morningstar Recommendation: Hold
Nachiket Moghe, CFA, Morningstar Analyst - 64 9 915 6776
We are reducing our medium and longer-term projections for Trade Me as we have had a change of view on the revenue outlook for the property and new goods marketplace businesses in light of the significant loss of listings and lack of traction in new goods. Furthermore, we have cut our estimates for operating margins in light of the cost pressures the firm is likely to face going forward to support top-line growth. As a result our net profit after tax estimates for fiscal 2014, 2015 and 2016 have reduced by 4.5%, 10% and 11% respectively. These changes have reduced our fair value estimate to NZD 3.80 per share from NZD 4.40 per share. The stock appears slightly undervalued as it is trading below our new fair value estimate. We continue to maintain our wide moat rating for the company but recent developments in the property business give us the impression that the network effect and brand strength are not as strong as previously thought.

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