Morningstar Equities Research

Morningstar Equities Research - FBU, FBU-NZ, WBC, WRT, FWD, GNC and FDC, FLT, PRY, WDC on price change

Fletcher Building Limited FBU, FBU-NZ| Earnings Growth on Track for Fletcher Building

Morningstar Recommendation: Reduce
Tim Mann, Morningstar Analyst -
Fletcher Building provided a strategic overview of the business at a recent investment conference. The company reiterated its focus on value creation through margin improvement, disciplined capital allocation, and active portfolio management. We have left our earnings estimates unchanged and fair value estimate remains at AUD 5.50 per share. We maintain our no-moat and high uncertainty ratings.

We note EBIT guidance for 2014 remains unchanged at NZD 610 million to NZD 650 million. We continue to believe Fletcher's leading brands and market positions leave it well positioned to benefit from the large pipeline of rebuild work in New Zealand and an expected improvement in activity in Australia. However, fierce competition, low barriers to entry, and largely commoditised products will continue to hamper the company's ability to build sustainable competitive advantages and generate excess returns. While Fletcher may be the large local player, price increases are kept in check by global players.

For New Zealand, the level of house building activity is expected to continue to underpin trading results. The repair of houses and infrastructure in Canterbury will boost activity levels. In Australia, the outlook remains uncertain with the mix of stand-alone versus multi-residential housing construction impacting demand, with apartments continuing to grow strongly (60% of new housing starts). Declining investment in mining and resources and reduced state government expenditure is likely to adversely impact activity levels.

Westpac Banking Corporation WBC| Business Flows Support Strong Profit and Dividend Growth for Westpac

Morningstar Recommendation: Hold
David Ellis, Morningstar Analyst -
Wide-moat rated Westpac Banking Corporation continues to build momentum across key businesses with lending and deposit volumes up on the back of stronger economic conditions, particularly in its home state of New South Wales. Westpac maintains the top-ranked investment platform based on fund flows, and consumer customer satisfaction remains high at about 79%. Strong competitive advantages, an Exemplary rating on stewardship of shareholder capital and our medium fair value uncertainty rating underpin our positive investment view. Westpac operates the lowest balance sheet leverage of peers with assets to equity of 15 times and the highest common equity tier-1 capital ratio of 8.8%. Tight operational control is a feature, with Westpac's globally competitive 41% cost-to-income ratio best of peers, complementing its top-ranked risk management position.

We are increasingly confident in our earnings and dividend forecasts for fiscal 2014 and 2015. Westpac's large exposure to the more heavily populated and economically stronger eastern states means a sharp deterioration in profits is very unlikely for the next 18 months at least. Our positive view translates to attractive growth in the fully franked ordinary dividend as well as upside potential of special dividends in 2015 and 2016. Asset quality continues to improve, providing positive implications for future earnings growth. Earnings and dividends are likely to grow around 7% per annum during our five year forecast period. Forecast profit growth will boost surplus capital, providing opportunities for active capital management. Westpac's loan loss to average loans is the lowest of peers at just 0.12% for first-half fiscal 2014. Loan impairments at these historic lows are unsustainable, and we continue to forecast impairments rise to 0.20% in the medium term. Our cash profit forecast for fiscal 2014 remains at AUD 7.7 billion, as does our AUD 35.00 fair value estimate. At current prices, the stock is close to fair value.

Westfield Retail Trust WRT| Westfield Proposal to Create Scentre Remains Unconvincing

Morningstar Recommendation: Hold
Tony Sherlock, Morningstar Analyst -
The vote to create Scentre Group on 29 May was deferred to 20 June (proxy forms are due 18 June) because of the release of new and material information; that is, Westfield Group's announcement that if Westfield Retail did not approve the proposal, it would pursue the separation of its Australian operations regardless, leaving Westfield Retail with a new external manager. Westfield Group advised it expected to begin the separation process immediately, with a revised plan to be presented to its securityholders by first-quarter 2014.

The board of Westfield Retail stated that the new information strengthens its support for the proposal as there is unlikely to be another opportunity to buy Westfield Group's Australian and New Zealand assets and associated management platform. We see merit to this argument, but we believe it is overwhelmed by the issue of having to pay an excessively high price for the management rights. As such, we retain our original advice, which is that the proposal being put to a vote involves a transfer of wealth from Westfield Retail to Westfield Group. On this basis, we recommend investors vote against the proposal to create Scentre Group.

The decision by Westfield Group to spin off its Australian assets even if the Scentre proposal doesn't proceed presents a risk, but the risk should be low. This is because the new owner of the management rights would have interests aligned with Westfield Retail, reflecting their common ownership of the shopping centres. Further, as Westfield Retail investors were comfortable owning a property portfolio without the management and development rights, there should not be a compulsion to overpay for them when they become available. The arguments that the creation of Scentre Group will be earnings accretive is unconvincing, as this comes from increasing leverage from 22.4% to 37.3% rather than an improvement in the cash-generating ability of the assets.

Fleetwood Corporation Limited FWD| Downside Earnings Risk for Fleetwood Amid Difficult Trading Conditions

Morningstar Recommendation: Accumulate
Tim Mann, Morningstar Analyst -
Given a continuation of poor market conditions in mining services, highlighted by recent profit warnings from service companies (notably Ausdrill and Austin Engineering), we have downgraded our earnings estimates for Fleetwood. This follows on from downgrades to our forecasts and fair value at Fleetwood's first-half 2014 result. We have reduced our estimates in 2014 and 2015 by 5% and 7% respectively. We have also reviewed our longer-term forecasts and have made cuts to reflect more subdued mining investment. Our fair value estimate falls to AUD 3.10 from AUD 3.50.

We maintain our no-moat and very high uncertainty ratings. Fleetwood's end markets remain very challenged. Price weakness in bulk commodities, such as coal and iron ore, has seen resource companies continue to restrict mining investment and focus on repairing balance sheets. This thematic looks set to continue into fiscal year 2015 and extend into 2016. According to the Bureau of Resources and Energy Economics' 2014 report, the combined value of committed and likely resource projects will decline by 75% to an estimated AUD 55 billion by 2018. This compares with a current 48 projects with a value of AUD 229 billion.

The high fixed costs embedded in mining services providers, coupled with a requirement to maintain high utilisation levels, is putting pressure on tendering. The risk of cost overruns and low margins is becoming an increasing feature for a number of companies. The sector historically performs well during upswings because of high earnings leverage, yet struggles during downturns. For Fleetwood, the mining accommodation sector remains oversupplied with demand softening, vacancy rates increasing, and daily room rates trending down. On a predominantly fixed-cost base, the risk to earnings is to the downside, in our view.

Graincorp Limited GNC| Network Rationalisation and Rail Efficiencies to Help GrainCorp Fend off Competition

Morningstar Recommendation: Hold

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