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Equity | Australia

27 May 2009

Australia Strategy Exporters losers from a higher AUD The AUD/USD has risen rapidly over the past month. In this note we identify the potential winners and losers from this change based on the likely impact on 2010F earnings. While many companies are affected, the impact is generally muted due to hedging, reflecting sound management. Table 1 : Top 5 potential winners and losers from a 1c rise in the AUD/USD Code

Company

Price

TP

(A$)

(A$)

LT rec

Impact 2010F NPAT

NPAT Impact

(A$m)*

(%)

(A$m)*

Positive earnings impact VBA

Virgin Blue

0.29

0.25

Hold

Positive

37.9

13.7

5.2

QAN

Qantas Airways

1.97

1.65

Sell

Positive

195.0

9.3

18.1

GFF

Goodman Fielder

1.29

1.20

Hold

Positive

179.2

1.2

2.2

BLD

Boral

4.30

3.75

Sell

Positive

60.0

1.0

0.6

CPU

Computershare

9.16

9.00

Hold

Positive

303.4

0.6

1.8

Negative earnings impact AWC

Alumina

1.29

1.12

Sell

Negative

134.0

-5.2

-7.0

ILU

Iluka Resources

3.26

3.36

Hold

Negative

204.0

-4.9

-10.0

PPX

PaperlinX

0.56

0.45

Sell

Negative

15.0

-4.5

-0.7

NCM

Newcrest Mining

32.24

34.56

Buy

Negative

808.0

-3.6

-29.0

STO

Santos

14.47

16.50

Buy

Negative

378.9

-3.2

-12.2

Priced at close of business 27 May 2009. Source: RBS estimates

Many stocks negatively affected, although the impact is generally muted As evidenced in our stock-specific analysis, many companies exhibit some degree of negative earnings impact from a rising AUD/USD, but in most cases the effect is quite muted. The impact is often limited due to FX hedging or the matching of foreign assets and liabilities, which often limits the exposure to earnings translation. However, the run in the currency could compound an already tough operating environment for stocks such as Billabong, BlueScope and OneSteel. Mining negatively affected, importers potential winners In terms of impact on earnings, a high proportion of stocks in the mining sector have a negative exposure to a rising AUD. While these stocks often have some degree of natural hedging, a substantial part of their cost base is in AUD while most revenues are in USD. Importers that source at least some of their materials/inputs in USD are potential winners from a rise in the AUD (eg, QAN has to 'import' fuel costed in USD). AUD/USD share price translation also significant In addition to the earnings impact, we identify stocks that report in USD and therefore would experience a translation impact from a strengthening AUD (eg, Brambles and News Corp). EU_90527b

ABN AMRO Morgans Limited (A.B.N. 49 010 669 726) AFSL235410 A Participant of ASX Group Sourced from RBS Equities (Australia) Limited, ABN 84 002 768 701, AFS Licence 240530 www.abnamromorgans.com.au

Important disclosures regarding companies that are the subject of this report and an explanation of recommendations and volatility can be found at the end of this document.


A strengthening AUD and corporate earnings In this note we look to highlight the impact of prolonged strength in the AUD versus the USD on company earnings. For all stocks covered by RBS that we believe will be most affected by a strengthening AUD (either positively or negatively), we have asked our analysts to calculate the impact of a 1c increase in the AUD/USD on 2010 earnings forecasts. Mining stocks the most negatively affected Our analysis has found mining to be the most negatively affected sector. A number of stocks, including Iluka and Alumina, have downside earnings risk. While these stocks have some degree of natural hedging, a substantial part of their cost base is in AUD while most revenues are in USD. Some recent recovery in commodity prices, which typically accompanies a rising AUD, should offset some of this pain. Airlines benefit – but a rising oil price may negate any gains Typical winners from a rising AUD are importers, as a higher AUD will push down ‘imported’ input costs. Several major companies import at least a part of their product and are likely to be positively affected by a stronger AUD. In particular, the airlines should benefit due to the lower cost of jet fuel in AUD terms, potentially acting as a buffer to a rising oil price. Goodman Fielder should also benefit from a higher AUD through lower wheat costs, which are priced in USD. Share price translation impact also a factor In addition to explicit earnings impact, we also highlight the companies that we believe would experience translation impact from an appreciating AUD. Companies that report their earnings and are modelled in USD would suffer from a higher AUD via the translation of their valuation (generally at the spot rate). These are summarised in Table 2 below. Table 2 : Stock price translation – exposure to rising AUD/USD Company

RBS analyst comment

ANN Ansell

Reports in USD. Translation of share price into AUD would have a marginal negative impact.

BXB

Brambles

Minimal direct impact on earnings: c10% from Australia would benefit from a stronger AUD. However, a generally weakening USD against most currencies would have a positive impact on USD earnings, while the translation of the share price into AUD would have a slight negative impact.

JHX

James Hardie Industries

Only a minor negative impact for Australian earnings (less than 15% of EBIT). JHX reports in USD for March year end, although translation of EPS into AUD is negatively affected by appreciation.

NWS News Corp

We value NWS in USD and convert to AUD at spot. Therefore, every +/-1% movement in USD has a +/-1% impact on valuation and target price.

RMD ResMed

RMD faces a negative impact from AUD appreciation against the USD, with c35% of COGS denominated in AUD. There is also a translation impact from other currencies.

Source: RBS estimates

But does an appreciating AUD also affect offshore fund flows? An appreciating AUD may also have the effect of making Australia a relatively less appealing investment destination for foreign investors. However, it is difficult to be more precise about this. Detailed stock-by-stock commentary Set out below is a comprehensive commentary on the effect of a rising AUD on our 2010 earnings forecasts. We included stocks covered by RBS where our analysts believe the rising AUD/USD will potentially have a significant impact on earnings.

Australia Strategy | Analysis | 27 May 2009

2


Table 3 : Earnings – stocks most affected by a 1c rise in the AUD/USD Code Company

Price

TP LT rec

(A$)

(A$)

Impact

RBS analyst comment

2010F NPAT (A$m)*

NPAT impact (%) (A$m)*

Capital Goods CSR

CSR Ltd

1.59

1.54 Hold

Negative

Hedging in commodities mutes the impact on earnings but impact more acute in sugar in FY10 vs FY09 as hedge book rolls off.

134.2

-1.5%

-2.0

LEI

Leighton

23.15

21.00 Hold

Negative

Currency exposure is based on the conversion of USD-based contracts, which is increasing.

592.7

-0.3%

-1.8

Consumer & Commercial Services BXB

Brambles

5.93

5.70 Hold

Positive

Minimal direct impact on earnings: c10% from Australia would be impacted by a stronger AUD. However, generally weakening USD against most currencies would have a positive impact on USD earnings. Although the translation of the share price into AUD would have a slight negative impact.

449.0

0.1%

0.5

BBG

Billabong

8.02

8.39 Sell

Negative

The appreciating AUD would negatively impact the translation of BBG's profits in the Americas (40% of group EBIT) and Europe (26% of group EBIT). For every 1c increase in the average full year rate for the AUD against the USD, our forecast 2010 net profit after tax decreases by 0.7%, while for the EUR the effect is an decrease of 0.4%.

173.0

-0.7%

-1.2

ALL

Aristocrat

3.61

3.15 Sell

Negative

The impact of a 1c change in the AUD/USD rate on 2010 NPAT is about A$1.5-1.7m.

168.8

-1.0%

-1.7

31.18

30.57 Hold

Negative

A stronger AUD would negatively impact earnings from overseas, which now account for about 50% of revenue. However, only 8% of income is from the Americas so the USD impact is relatively low.

1002.7

-0.1%

-1.0

Diversified Financials MQG

Macquarie Group

Energy CTX

Caltex

11.48

16.35 Buy

Negative

Globally (ex-US) downstream companies tend to have greater margin exposure to the USD than upstream companies, ie, a falling USD has a negative impact on margins and vice versa. This is due to the fact that input costs tend to be in USD and sales are based on global product prices also denominated in USD, but operating costs generally are in the local currency. In Australia, product prices are set at import price parity, primarily Singapore gasoline and diesel prices. Therefore, while oil products in Australia are sold in AUD, the pricing mechanism is based on a direct translation of the underlying USD price for comparable imports. In our view, this meaningfully reduces the margin impact on Caltex of movements in the USD exchange rate. In our opinion, a stronger AUD is likely to be a small negative for CTX.

409.5

-1.6%

-6.6

ERA

Energy Resource

25.96

23.10 Hold

Negative

Positive for revenue and some costs, would increase cost of imported acid.

281.0

-2.3%

-6.4

ORG

Origin Energ

15.15

17.50 Buy

OSH

Oil Search

STO

Santos

14.47

WPL

Woodside

42.62

5.41

Negative

Hedged roughly 40% for 2010.

667.6

-0.3%

2.0

Negative

Oil Search’s earnings are all USD-denominated. The company also reports in USD, therefore its only AUD operating costs are related to headcount and head office. This is likely to remain constant over the next few years. Offsetting the medium-term revenue-related negatives of a rising AUD are the anticipated capex requirements of the PNG gas commercialisation developments.

139.4

-0.0%

-0.0

16.50 Buy

Negative

Santos’s earnings are largely USD-denominated: we estimate 65% of revenues in FY08 were generated in USD. The level of exposure going forward would be largely influenced by production levels from the company’s oil developments. A large proportion of capital expenditure is USD-denominated. A stronger AUD has a small negative impact on margins.

378.9

-3.2%

-12.2

44.00 Hold

Negative

Woodside’s earnings are largely USD-denominated: we estimate 90% of revenues in FY08 were generated in USD. We anticipate this percentage will remain relatively unchanged over the next few years, with revenue growth of oil, condensate, LNG and LPG products (USD-denominated) outweighing domestic gas (AUDdenominated). Offsetting this is Woodside’s significant ongoing capital and exploration expenditure, which is likely to be largely USD-denominated. A stronger AUD, therefore, has a negative impact on revenue, and an offsetting negative impact on capital expenditure and costs. Overall a small negative for cash margins.

1513.2

-2.3%

-34.9

5.20 Hold

Australia Strategy | Analysis | 27 May 2009

3


Table 3 : Earnings – stocks most affected by a 1c rise in the AUD/USD (cont’d) Code Company

Price (A$)

TP LT rec

Impact

RBS analyst comment

(A$)

2010F NPAT (A$m)*

NPAT impact (%) (A$m)*

Food & Staples Retailing CCL

C-C Amatil

8.70

9.20 Hold

Positive

Commodity costs priced primarily in USD.

479.2

0.2%

1.0

FGL

Foster's Group

4.90

5.50 Hold

Negative

Primarily translation of US earnings. FGL hedging P&L through higher levels of USD debt. GBP other key exposure.

806.9

-0.3%

2.2

GFF

Goodman Fielder

1.29

1.20 Hold

Positive

NZD key exposure. USD exposure through wheat and edible oil costs, which are priced in USD.

179.2

1.2%

2.2

Healthcare COH

Cochlear

54.30

54.00 Buy

Negative

Most FY10F sales come from offshore, 43% of FY10F EBIT in the US.

160.2

-0.1%

-0.2

CSL

CSL Ltd

30.15

45.50 Buy

Negative

Historically major exposure has been USD/CHF - this has been mitigated by internal hedges. c40% of earnings in the US.

1421.6

-1.4%

-19.9

RMD

ResMed Inc

4.72

5.50 Hold

Negative

RMD faces a negative impact from AUD appreciation against the USD, with c35% of COGS denominated in AUD. There is also a translation impact from other currencies.

170.9

-1.9%

-3.3

SHL

Sonic Health

11.97

13.00 Hold

Negative

35% of revenues earned offshore. 20% of FY10F EBIT in the US.

339.3

-0.4%

-1.4

4.28 Hold

663.4

-0.7%

-4.6

n/a

-1.0%

-15.4

Insurance AXA

AXA Asia Pac

QBE

QBE Insur

Negative

AXA derives c47% of operating profit from HK.

19.49

3.83

29.45 Buy

Negative

US exposure is around 40% of revenue.

Materials AMC

Amcor

4.92

5.30 Buy

Negative

Impact is mainly translation. Natural hedge through high level of offshore debt.

389.9

-0.8%

-3.1

AWC

Alumina

1.29

1.12 Sell

Negative

Earnings are heavily dependent on Alcoa of Australia, a higher AUD would decrease alumina margins. The translation of foreign (USD) earnings would also fall.

134.0

-5.2%

-7.0

BHP

BHP Billiton

34.65

29.55 Hold

Negative

BHP is highly diversified, which provides some natural hedging, but a higher AUD would compound the negative effect of falls in iron ore and coking coal prices.

9,317.0

-0.7%

-68.9

BLD

Boral

4.30

3.75 Sell

Positive

Facing significant USD operating losses, translation of losses helped by rising AUD.

60.0

1.0%

0.6

BSL

BlueScope Steel

2.17

2.15 Hold

Negative

Modest negative impact on translated offshore earnings and export sales.

100.0

-1.6%

-1.6

ILU

Iluka Res

3.26

3.36 Hold

Negative

All costs are now in AUD while revenue is in USD.

204

-4.9%

-10.0

JHX

James Hardie

4.35

4.05 Hold

Positive

Reports in USD. Positive impact for AUD earnings on translation but greatest impact is on valuation on conversion of USD EPS into AUD.

38.8

0.40%

0.16

LGL

Lihir Gold

3.17

3.56 Buy

Negative

Benefit of translation of USD earnings and potential reduction in AUD denominated capital and operating costs

386.0

n/a

n/a

NCM

Newcrest Mining

32.24

34.56 Buy

Negative

A large component of operating costs is in AUD while revenue is in USD.

808.0

-3.6%

-29.0

200.0

-0.3%

-0.5

15.0

-4.5%

-0.7

OST

OneSteel

2.55

2.10 Sell

Negative

Negative impact on iron ore sales, offset by lower input costs.

PPX

PaperlinX

0.56

0.45 Sell

Negative

Impact is mainly indirect and related to the negative effect on import parity prices, which supports domestic selling prices. A weaker USD makes it harder for European paper prices to rise.

RIO

Rio Tinto

64.35

58.62 Hold

Negative

RIO is diversified but has a natural hedge because of global assets. RIO has greater exposure to the AUD than BHP.

4,941.0

-1.1%

-54.8

7.03

6.84 Hold

Negative

US construction and earnings exposure would be negatively impacted by a stronger AUD.

242.8

-0.5%

-1.2

10.61

9.70 Hold

Negative

Negative based on proportion of US earnings despite existence of an active hedging program.

2094.6

-0.8%

-16.8

9.16

9.00 Hold

Positive

Profit now reported in USD so a weak USD could hurt earnings with c40% of revenue from outside Nth America. However, the dividend paid in AUD, so this could be negatively impacted. Plus investors still consider the AUD/USD when looking at the stock.

303.4

0.6%

1.8

Real Estate LLC

Lend Lease Corp

WDC

Westfield Group

Software & Services CPU

Computershare

Transport MIG

Macquarie Infrastructure

1.45

2.52 Buy

Negative

Main impact would be on revaluations of US assets

-26.8

-2.5%

-0.7

QAN

Qantas Airways

1.97

1.65 Sell

Positive

About 40% costs USD-related; does not include the impact of provisions for forex movements on future return value of leased aircraft hedging.

195.0

9.3%

18.1

TCL

Transurban

4.13

5.3 Hold

Negative

Minimal impact from single US asset.

15.8

-0.1%

-0.0

VBA

Virgin Blue

0.29

0.25 Hold

Positive

Most exposure is cost-related – aircraft leases and fuel.

37.90

13.7%

5.2

Priced at close of business 27 May 2009. Source: RBS estimates

Australia Strategy | Analysis | 27 May 2009

4


RESEARCH TEAM ROGER LEANING CHRIS BROWN FIONA BUCHANAN NICK HARRIS MICHAEL KNOX JAMES LAWRENCE JOSEPHINE LITTLE BELINDA MOORE

BRISBANE BUNDABERG BURLEIGH HEADS CAIRNS CALOUNDRA CAPALABA CHERMSIDE EMERALD GLADSTONE GOLD COAST IPSWICH MACKAY MILTON NOOSA REDCLIFFE ROCKHAMPTON SPRING HILL SPRINGWOOD SUNSHINE COAST TOOWOOMBA TOWNSVILLE YEPPOON SYDNEY ARMIDALE BALLINA BALMAIN

-

Head of Research Senior Analyst Senior Analyst Analyst Director of Strategy & Chief Economist Fixed Interest Analyst Analyst Senior Analyst

(07) 3334 (07) 4153 (07) 5520 (07) 4052 (07) 5491 (07) 3245 (07) 3350 (07) 4988 (07) 4972 (07) 5592 (07) 3202 (07) 4957 (07) 3114 (07) 5449 (07) 3897 (07) 4922 (07) 3833 (07) 3808 (07) 5479 (07) 4639 (07) 4771 (07) 4939 (02) 8215 (02) 6770 (02) 6686 (02) 8755

4888 1050 8788 9222 5422 5466 9000 2777 8000 5777 3995 3033 8600 9511 3999 5855 9333 7588 2757 1277 4577 3021 5000 3300 4144 3333

SCOTT POWER TOM SARTOR TAMARA STRETCH TANYA SOLOMON PAUL STEVENSON SAM TURNER MARCEL VON PFYFFER

ABN AMRO MORGANS OFFICES CHATSWOOD COFFS HARBOUR GOSFORD HURSTVILLE MERIMBULA NEUTRAL BAY NEWCASTLE NEWPORT ORANGE PARRAMATTA PORT MACQUARIE SCONE WOLLONGONG MELBOURNE BERWICK BRIGHTON CAMBERWELL GEELONG TRARALGON WARRNAMBOOL CANBERRA ADELAIDE PERTH BUNBURY DARWIN HOBART

-

Senior Analyst Analyst Analyst Analyst Analyst Analyst Associate Director - Strategy

(02) 9411 (02) 6651 (02) 4325 (02) 9570 (02) 6495 (02) 8969 (02) 4926 (02) 9998 (02) 6361 (02) 9615 (02) 6583 (02) 6544 (02) 4227 (03) 9947 (03) 9796 (03) 9519 (03) 9813 (03) 5222 (03) 5176 (03) 5559 (02) 6232 (08) 8464 (08) 9261 (08) 9791 (08) 8981 (03) 6236

8988 5700 0884 5755 2869 7500 4044 4200 9166 4500 1735 3144 3022 4111 2676 3555 2945 5128 6055 1500 4999 5000 0888 9188 9555 9000

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A Buy/Sell implies upside/downside of 10% or more and a Hold less than 10%. The target price is the level the stock should currently trade at if the market accepted the analyst’s view of the stock, provided the necessary catalysts are in place to effect the change in perception. If it is felt that the catalysts are not fully in place to effect a re-rating of the stock to its warranted value the target price will differ from ‘fair’ value. Given the volatility of share prices and our pre-disposition not to change recommendations frequently, these performance parameters should be interpreted flexibly. Performance in this context only reflects capital appreciation and the horizon is 12 months. For listed property trusts (LPTs) the recommendation is based upon the target price plus the dividend yield, ie total return. A Buy implies a total return of 10% or more; a Hold 5-10%; and a Sell less than 5%. Absolute performance, short-term (trading) recommendation: The Trading Buy/Sell recommendation implies upside/downside of 3% or more. The trading recommendation time horizon is 0-60 days. Each stock has been assigned a Volatility Rating to assist in assessing the risk of the security. The rating measures the volatility of the security's daily closing price data over the previous year relative to other stocks included in either the S&P/ASX200 Index (large caps) or the Small Ordinaries Index (small caps) of which it is a member. This rating is a quantitative (objective) measure provided as an additional resource and is independent of the qualitative research process undertaken by our research analysts. A rating of Low indicates very little movement in price over the previous year (Coefficient of Variation < 4 for small caps or < 5 for large caps). A Moderate rating implies average price movement over the previous year (Coefficient of Variation of 9 - 21 for small caps or 7.25 - 15 for large caps). A High rating implies significant price movement over the past year (Coefficient of Variation greater than 25 for small caps or 35 for large caps). PRIVACY Personal information held by ABN AMRO Morgans Ltd may have been used to enable you to receive this publication. If you do not wish your personal information to be used for this purpose in the future please advise us, including your account details to your local ABN AMRO Morgans Ltd office or to Reply Paid 202, GPO Box 202 Brisbane Qld 4001.

Australia Strategy | Disclosures Appendix | 27 May 2009

The rising AUD  

How the rising AUD/USD can affect Australian company earnings