Stock Takes: Financial markets hang on Fed’s call, Air New Zealand faces turbulence

Financial markets remain delicately poised as they await the US Federal Reserve’s next move.

Tightening too early runs the risk of choking off an economic recovery, while tightening too late runs the risk of asset bubbles developing.

This week US Federal Reserve chairman Jerome Powell moved to calm the horses, saying the Fed would not raise interest rates too quickly.

“We will not raise interest rates pre-emptively because we fear the possible onset of inflation,” Powell said.

“We will wait for evidence of actual inflation or other imbalances,” Powell said.

Whatever happens in the world’s biggest economy is sure to flow through to others.

Harbour Asset Management’s Shane Solly said Powell’s comments added to the “whole macro washing machine” that has been the financial markets.

“It means that the prospects of an aggressive tightening have been moved off the list,” he said.

Differing views on where inflation goes from here has resulted in a battle in the sharemarkets between value stocks and growth stocks.

“For value to perform, we need to see this economic recovery to keep on firing away until we see interest rates going up,” he said.

“For growth, it is almost the opposite. If activity slows, then interest rates don’t go, then that sector will do relatively well.

“So we are seeing that competition between the two going on at the moment,” Solly said.

“Really what it comes down to is that you have got to take a medium term view.

“From our perspective, it’s about focusing on stocks that really drive their own direction.

“But investors need to be picky because valuations are very full.”

Clouds ahead for Air NZ

Analysts from separate firms see plenty of clouds ahead of Air New Zealand.

Forsyth Barr has downgraded the airline from ‘neutral’ to ‘underperform’ while Jarden has downgraded its12-month target price to $0.95 a share (from $1.10), reflecting the earnings downgrades and a capital raise of around $1.2 billion being highly dilutive.

The analysis was done before further disruption to the airline’s transtasman operation caused by Tuesday’s pause in bubble flights between Sydney and New Zealand – the busiest route.

Last week in a market update Air New Zealand said its pre-tax loss in the 2022 financial year could be as high as this year – $450 million.

Forsyth Barr analysts Andy Bowley and Matt Noland said the company’s return to profitability will take longer than previously anticipated.

“While domestic demand is robust, and transtasman demand is likely to build over the next six to nine months, the recovery in long haul is unlikely to be a feature until financial year 2023, even if border re-openings begin early 2022.”

Despite an expected increase in passenger demand, higher fuel costs and $300m lower government support mechanisms (wage subsidies, airfreight scheme and air support package) mean material losses are likely to continue.

Cash burn has been mitigated in recent months; the drawn-down portion of the $1.5b Crown funding facility remains at $350m.However, cash burn is likely to deteriorate from October this year when the current PAYE deferral scheme ends.

Air New Zealand’s recovery is still subject to a large degree of uncertainty, ongoing losses and a significant capital raise later this year, Bowley and Noland say.

Jarden analyst Andrew Steele said the firm continued to forecast Air New Zealand will need to raise $1.2b of additional equity, “an amount which we no longer view as a conservative estimate.”

“We retain our sell rating, reflecting our view that given Air New Zealand’s requirement for what will likely be a highly dilutive capital raise, material ongoing near-term losses and lack of comfort on the timing and trajectory of any earnings recovery, the shares present a negatively skewed risk/reward profile,” he said.

While the company had clearly reset earnings expectations, Jarden continued to see operational challenges for border re-openings and further upside risk to jet fuel costs, which could drive further earnings downgrades and earnings recovery uncertainty at a time when the company is looking to raise new equity.

Mercury-Trustpower deal

Forsyth Barr has maintained its “underperform” rating on Mercury’s in the wake of the power company’s $441m acquisition of Trustpower’s retail business.

The deal more than doubles its connection numbers, providing its retail business with scale and enabling Mercury to enter the broadband market, Forsyth Barr said in its assessment of the deal.

Execution will be critically important if Mercury is to deliver $35m of synergy benefits by 2024, which is on top of the $55m EBITDAF the transaction is expected to provide, the broker said.

While the deal adds to Mercury’s EBITDAF growth profile, it also adds to its growing debt position such that we have left our dividend forecast unchanged until 2024.

The acquisition will see Mercury become the largest mass market energy retailer, provides scale.

While the deal added to Mercury’s earnings profile, it also added to its growing debt.

“While we are slightly positive on the deal (the price paid is not unreasonable) Mercury remains expensive in our view, and we retain our underperform rating.”

The deal transforms Mercury retail business and it will become the largest electricity retailer by connections, about 100,000 more than Genesis Energy and have a 27 per cent market share.

It also becomes the second-largest gas retailer and enables Mercury to enter the telco market, a source of cross-selling opportunities.

“We also suspect a driver of the transaction is it helps justify a transformative IT spend, as both the Mercury and Trustpower IT platforms need investment.”

“Overall, we are modestly positive on the acquisition. The price paid appears reasonable and the strategic benefits of the deal are clear. “However, Mercury has a lot on its plate at present and execution will be important.”

Mercury will become the largest electricity retailer (by connections) and the second-largest gas retailer.

It will still sit third behind Meridian Energy and Genesis Energy on physical volumes sales. “Nevertheless, retailing utilities is a scale game and this deal significantly improves Mercury’s scale,” Forsyth Barr said.

A pure play

Trustpower’s sale of its retail business will make it a near pure-play generation business.
It will be a far simpler business going forward and earnings should be less volatile.

Trustpower, which is just over half owned by dual-listed Infratil, has indicated its capital structure and dividend policy are under review.

“Based on its track record, we expect Infratil will seek to return capital to shareholders rather than leave it within Trustpower,” Forsyth Barr said. “We have assumed an $1.00 special dividend (although it could be as much as NZ$1.50).”

No cheques

New Zealand banks no longer accept cheques, so investors wanting to take part in Precinct Property’s equity raising have had to go through the retail offer website, with all payments by direct credit.

There were no paper application forms, and shareholders with only postal addresses will simply be sent a letter of entitlement linking to the online-only offer document.

Chapman Tripp assisted Precinct with the offer, having earlier worked with other NZX listed clients Me Today and Savor on similar offer structures.

Morrison for Icon?

The infrastructure money is coming for Goldman Sachs and Queensland Investment Corp’s (QIC) cancer care provider Icon Group, according to the Australian Financial Review.

Morrison and Co, the Kiwi infrastructure fund manager responsible for Infratil, has started assembling a deal team and is readying for Icon Group’s upcoming auction, the AFR’s Street Talk said.

The paper said it was understood Morrison and Co had called in RBC Capital Markets bankers to help it run the numbers for what is said was likely to be A$2 billion-plus play.

Morrison and Co did not respond to requests from Stock Takes for confirmation of the report.

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