Research Notes

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Research Notes

Powering to 40 on a positive cost surprise

Xero
3:27pm
May 23, 2024
Management hit their aspirational rule of 40 years ahead of our expectations. This was largely due to stronger than expected cost control. FY24 revenue was inline while EBITDA, NPAT and FCF and well above expectations, on lower costs. Management had guided to expenses (OPEX plus D&A) at ~75% of revenue in FY24, but it came $50m lower than planned, at ~73%. Some of the FY24 cost savings were timing related, due to slower than anticipated staff hires, however the result was a decent beat and good, with & without, the cost slippage. Having now firmly established the base, spend is expected to lift in FY25 and cost guidance is for ~73% expense ratio, on higher revenue. We upgrade our forecasts and lift our Target Price to $140. Hold retained.

Timing is everything

The Reject Shop
3:27pm
May 23, 2024
The timing of store openings and closures has meant that total sales growth in 2H24 has fallen short of expectations. With no mitigating reduction in the operating cost base, this flows through to group EBIT, which has been guided to $4.0-5.5m, some $2.3-3.8m lower than consensus expectations. LFL sales have held up well and well above peers in the retail sector, with good growth in both price and volume of essential items and positive signs from the new general merchandising strategy. 2H24 LFLs to date are +3.3% and total sales +4.1%. We have lowered our estimates for FY24 in line with the guidance given (just a month out from the year-end), with a modest flowthrough to FY25. Lower earnings and lower peer company multiples take our target price down from $5.40 to $4.65. This keeps us on an ADD rating, conscious of TRS’s single-digit FY26F P/E, 6.5% FY26F dividend yield and $2.16 per share cash backing. With this note, lead coverage of TRS transfers to Emily Porter.

SaaS+ should make 15-20% the new black

Technology One
3:27pm
May 22, 2024
TNE’s 1H24 result and FY24 guidance were in line with expectations. ARR keeps compounding and should easily exceed $500m ARR within the next 12 months. TNE’s progressive introduction of SaaS+ is, in our view, a step change which productises implementations with a view to fast tracking time-to-value for customers. Implementation is a massive pain point for ERP implementations and TNE is uniquely placed to soften the blow. SaaS+ (Implementation as a Service) is great for customers, unique to TNE’s business model and is value accretive. Using SaaS+ to remove the implementation bottleneck so should also mean TNE can sell more software solutions than historically. All going to plan, TNE’s medium term profit growth rate should accelerate from 10-15% to ~15-20%. We upgrade our recommendation to an ADD with a $20.50 target price.

Time to hang up

Telstra Group
3:27pm
May 21, 2024
Telstra (TLS) announced another round of organizational changes aimed at cost reductions. They reaffirmed FY24 guidance and provided early FY25 guidance. We reduce our EPS forecasts by 5-11%, downgrade our Target Price from $4 to $3 and downgrade our recommendation from Hold to Reduce.

1H24 earnings: Undisputed

Aristocrat Leisure
3:27pm
May 17, 2024
Aristocrat Leisure (ALL) delivered an impressive 1H24 result surpassing both our and market expectations. NPATA in the first half was $764m and up 16% yoy. This was 13% above our forecast, 10% above consensus and up 13% on a constant currency basis. Operating profit (EBITA) was up 15% to $1,027m, 12% higher than our estimate. North America revenue (excluding LATAM) achieved 6% growth, ~4% above forecast. ALL’s digital gaming division, Pixel United, delivered impressive 17% growth in profit, 6% above our forecasts. EPSA was up 19% to 118.5c, 12% above our estimate. DPS was up 20% to 36.0c. A $350m extension to ongoing buy-back program was also announced. Consequently, our estimates of EPSA on a fully diluted basis increase by 9% in both FY24 and FY25. We upgrade ALL from a Hold to Add recommendation with a 12-month target price of $50. We forecast FCF and dividend yield of 5% and 2% respectively for FY24.

Investor Day 2024

Worley
3:27pm
May 14, 2024
WOR’s 2024 investor day showcased solid momentum across the group as it looks to capitalise on opportunities across its target markets. With WOR’s drivers and sustainability metrics remaining broadly positive, we came away from the event optimistic about its ability to drive value and margin expansion through the cycle. Our forecasts and $18.00 target price are unchanged, supporting our Add rating.

All eyes on the end of May

Avita Medical
3:27pm
May 14, 2024
AVH posted its 1Q24 result which was in line with previously revised lower guidance. Importantly the CY24 guidance and cashflow break-even for 3Q25 has been reconfirmed. The key catalyst we are focused on is the RECELL GO approval targeted for 30th May (US time). We are confident in this approval and subsequent share price lift. A higher cost base sees a downward revision to forecasts and target price. Add recommendation maintained.

1Q24: Global sales surpass market expectations

Light & Wonder
3:27pm
May 9, 2024
Light & Wonder Inc. (LNW) delivered strong quarterly growth with Consolidated Revenue of US$756m, 2.5% above Visible Alpha (VA) consensus expectations (VA US$738m), growing 13% on the pcp. This was driven by double digital growth across Gaming, SciPlay and iGaming segments and marks 12 consecutive quarters of revenue growth for the company. The Gaming segment was the key outperformer, primarily driven by Global Gaming Machine revenue growth which was up 30%. Group adjusted EBITDA (AEBITDA) increased 13% yoy to US$281m and was 2% above VA consensus expectations. LNW’s net debt ratio was 3.0x (LTM AEBITDA) and FCF for the quarter was US$93m. VA consensus currently expects LNW to deliver Consolidated Revenue and AEBITDA growth of 8.4% and 8.2% respectively in 2Q24 vs the prior year.

Weather impacts driving a soggy 2H24

Lindsay Australia
3:27pm
May 7, 2024
LAU’s trading update came in below expectations as wet weather impacts on key growing regions have driven lower transport volumes across its fresh logistics business, with outages across LAU’s east-west rail corridor also a negative contributor to the group during the half. LAU’s revised FY24 EBITDA guidance is now expected to be ~$88m-$94m, representing a ~11-13% downgrade from its prior guidance. Whilst weather related factors leading to LAU’s guidance downgrade appear to be largely one-off in nature, we adopt a more cautious approach to forecasting the rate of recovery in horticulture volumes and utilisation rates as weather impacts abate. This sees our underlying EBITDA (pre-AASB16) forecasts reduce by -13%/-7%/-5% in FY24-26F. We maintain our Add rating on LAU, with a revised target price of $1.20ps (prev. $1.45).

Growing exposure to Global energy transition

Worley
3:27pm
May 3, 2024
Worley (WOR) is a leading global professional services firm providing engineering design, project management and maintenance services, with a growing focus on being the go-to sustainable solutions provider to the energy, chemicals and resources markets. WOR is leveraged to strong tailwinds associated with underlying investment across its key end markets. This, in our view, supports our 18.7% EPS CAGR between FY24-FY26F. The recent sell-down of WOR’s largest shareholder Sidara (Dar Group) at $14.35 represents a rare liquidity event driving near-term volatility in the share price. We initiate coverage on WOR with an ADD rating and $18.00ps target price.

News & Insights

One year is a long time in politics. After delivering a budget that straddled the right balance between balance sheet repair and fiscal expansion, the 2024/25 budget was delivered with an eye to next year’s election. Tonight’s announcements centred around cost-of-living relief for all and the well-publicised plan for a “Future Made in Australia” promising over $22bn in spending over the next ten years but also bringing higher deficits over the forecast period.

One year is a long time in politics. After delivering a budget that straddled the right balance between balance sheet repair and fiscal expansion, the 2024/25 budget was delivered with an eye to next year’s election. Tonight’s announcements centred around cost-of-living relief for all and the well-publicised plan for a “Future Made in Australia” promising over $22bn in spending over the next ten years but also bringing higher deficits over the forecast period.

Treasurer Jim Chalmers’ third Budget shows the government is on track to achieve a budget surplus of $9.3bn, a $10bn turnaround on MYEFO that predicted a $1.1bn deficit. The surplus was again driven by a range of upside surprises to revenue, e.g. the strong labour market, solid wage growth and net overseas migration. Tax revenue was considerably higher than the previous forecast, with the government’s tax receipts at 25.8% of GDP - the highest level since 2007.

An improved fiscal position provides scope for the government to increase spending on temporary cost-of-living relief while committing to the “Future Made in Australia” program which involves tax concessions and subsidies to industries the government deems critical to achieving its net zero target. $7.2B has been committed to cost-of-living relief measures including energy rebates and rent assistance. However, there has been no meaningful attempt to tackle structural pressures from NDIS, aged care, and health care, which has seen growth outpace inflation over the past few years.

Ahead of the election next year, this was another chance for the government to demonstrate their economic credentials. With a helping hand from commodity prices and a strong labour market, we think the government has played it safe, opting to leave meaningful structural reform aside. In summary, the measures announced today is unlikely to move the dial on market sentiment.

Key highlights

•        Spending the surplus - At the headline level, a surplus of A$9.2b is expected in 2023-24 (+0.3% of GDP), significantly improving upon the $13.9b (0.5% of GDP) deficit predicted at last year’s Budget. That said, deficits are expected over forward estimates as commodity prices are forecast to ease and unemployment set to rise. Also, extra spending commitments (“Future Made in Australia”, stage 3 tax cuts) will weaken the fiscal position over the forecast period. The

•       Marginally inflationary but no big deal for equity markets – taking everything into account, a surprise surplus, the coming stage 3 tax cuts, a bump in government spending, and some targeted measures to address cost-of-living pressure should not worry investors. Importantly for the market, a strong fiscal position and few inflation-inducing spending measures should also reassure investors that a slowdown is possible without a recession.

•       Few consumption levers pulled this year – A feature of the previous Labor Budget’s such as large one-off cash payments, new welfare programs and tax offsets were notably absent. Instead, energy bill relief and the reworked stage 3 tax cuts are expected to do the heavy lifting on cost-of-living support. Big spending programs were replaced by targeted relief to and low-medium income households such as rent assistance. So this Budget will not provide the sugar hit to retailers we’ve seen over the past few years coming out of COVID.

•       Budget assumptions and a cut expected to net overseas migration – Forecasts provide a low hurdle for the December MYEFO or next year’s pre-election Budget. Key commodities are assumed to decline from elevated levels with iron ore price assumed to decline from US$117/tonne to US$60/tonne by March 2025; the metallurgical coal spot price declines from US$227 to US$140/tonne; the thermal coal spot price declines from US$105 to US$70/tonne. AUD is expected to remain at 65c through the forecast period. The Budget expects net overseas migration to be 395,000 this year, after 528,000 last year. The government forecasts that it will fall to 260,000 next year, to 255,000, and to 235,000 in the following years.

Our thoughts

Labor’s third Budget delivered another surprise surplus for the government leaving some wiggle room to spend ahead of the 2025 election year. While the “Future Made in Australia” promises to drive investment in the green economy, many questions remain about its implementation and effectiveness in competing in industries where we lack a comparative advantage. Implementing the re-cut stage 3 tax cuts and some cost-of-living relief will provide some support for domestic demand, which in our view is mildly inflationary but unlikely to move the dial meaningfully on corporate profitability.

Successive governments have lacked the determination to bring about significant structural reform, chiefly around genuine tax reform, productivity and housing. This Budget is no different. The lack of genuine long-term reform at time when the federal balance sheet has been boosted by elevated tax revenues, a strong job market and cyclically high commodity revenue is a missed opportunity for Labor.

In our view, the Budget is unlikely to bring about significant revisions to corporate earnings, however the ongoing commitment to support the vulnerable parts of the economy should help market sentiment and support earnings confidence. Moreover the surplus has reinforced Australia’s sovereign credit rating which can be viewed as favourable for inbound investment. We also see company dividends as sustainable if economic conditions hold. We prefer a targeted portfolio approach favouring quality (strong cashflow and market position e.g. COL, TWE, DBI, QBE, CSL), sectors linked to higher-for-longer inflation (Energy, Resources) and select cyclicals (MGH, CWP, QAL, BLX, ACF). See our Best Ideas for our most preferred exposures.

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Jim Chalmers talks as if he is delivering a big surplus. Certainly, $9.3 billion sounds like a lot of money. However, last year Australian GDP was an amazingly large $2.6 trillion. The Budget Papers (Table 1.2) show this budget surplus as just a small budget balance of 0.3% of GDP. Of course, a budget balance of 0.3% is better than no balanced budget at all.

Jim Chalmers talks as if he is delivering a big surplus. Certainly, $9.3 billion sounds like a lot of money. However, last year Australian GDP was an amazingly large $2.6 trillion. The Budget Papers (Table 1.2) show this budget surplus as just a small budget balance of 0.3% of GDP. Of course, a budget balance of 0.3% is better than no balanced budget at all.

This Budget seems to have been produced with detailed election polling in mind. There is something for everyone. There is a handout or a hand-up for every identifiable voting group. The Budget gives the government the flexibility to launch into an election campaign almost any time in the next year. Right now, in this document, almost every interest group is taken care of.

This is important because the major economic parameters tells us that the economy is softening. GDP growth for 2023-24 is only 1.75%. This is down from 3.1% in 2022-23. As a result, unemployment is expected to rise to 4% in the middle of 2024 and 4.5% by the middle of 2025. This unemployment of 4.5% stays at this level for three consecutive financial years up to and including 2026-27.

The result of this continued period of higher unemployment is that inflation falls. Still, it takes until the middle of 2027 for the RBA inflation target of 2.5% to be achieved. This low inflation is bought at the cost of a weak demand for labour.

Outlook for the Terms of Trade

The good news that has been delivered over the last couple of years in the shape of balanced budget has been achieved as a result of the highest terms of trade that has ever been recorded. Budget Paper 1, page 67, tells us that the terms of trade is forecast to decline from here over the next three years. The terms of trade is expected to stabilise in 2025-26 at around the average level of the past 15 years. Commodity prices are assumed to reach their long-term levels by the end of the March quarter 2025.

As we said, this is a budget which has something for everyone. The overwhelmingly largest function of expenditure is Social security and welfare. This accounts for spending of $266.7 billion, or 36.3% of outlays. Next comes Health with $112 billion, or 15.3% of outlays. Education comes next with $53 billion, or 7.2% of outlays. Following these is Defence with total expenditure of $48 billion, or 6.5% of expenditure.

The estimates of the increases in Australian General Government Expenses by Function show some very interesting movements. Of course, the largest total increase is Social security and welfare, with an increase of $14.35 billion. However, what is interesting in these numbers is the percentage changes.

By far the biggest percentage increase is spending on fuel and energy. These are subsidies for keeping prices low. The fuel and energy sector is seeing increases in expenditure of 51.6%. This is an increase in spending of $6.84 billion. The next big percentage of increased spending is Housing and community amenities with an increase of 25.7%. This is a total increase in spending of $2.044 billion.

Final thoughts

Jim Chalmers talks as if he is delivering a big surplus. The Budget Papers (Table 1.2) show this budget surplus as just a small budget balance of 0.3% of GDP. Of course, a budget balance of 0.3% is better than no balanced budget at all.

This Budget seems to have been produced with detailed election polling in mind. There is something for everyone. There is a handout or a hand-up for every identifiable voting group. The Budget gives the government the flexibility to launch into an election campaign almost any time in the next year. Right now in this document, almost every interest group is taken care of.

This is important because the major economic parameters tell us that the economy is softening. GDP growth for 2023-24 is only 1.75%. This is down from 3.1% in 2022-23. The result of this is that unemployment is expected to rise to 4% in the middle of 2024 and 4.5% by the middle of 2025. This 4.5% of unemployment stays at this level for three consecutive financial years.

Perhaps the government will want to move to an election before this period of weak employment and higher unemployment really sets in.

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From a Wealth Management perspective, this Budget is a non-event. Any significant announcements have already been made, particularly in relation to taxation and superannuation. Feedback to the government from Industry and Associations has largely been ignored. Nothing to see here.

From a Wealth Management perspective, this Budget is a non-event. Any significant announcements have already been made, particularly in relation to taxation and superannuation. Feedback to the government from Industry and Associations has largely been ignored. Nothing to see here.

In Summary

Taxation

The amended Stage Three tax cuts legislated earlier this year will apply from 1 July 2024. The original (Coalition) Stage 3 tax scale was amended to:

  • Reduce the 19% rate to 16% on income up to $45,000
  • Reinsert a 37% rate on income between $135,000 and $190,000 (previously 30%)
  • Bring the top rate of 45% to apply from $190,000 (previously $200,000)

Superannuation

  • From 1 July 25, under the previously announced “Better Targeted Superannuation Concessions” legislation – also known as Div296 tax - a proportion of earnings on total super balances exceeding $3 million will attract an additional tax of 15%. Refer to our Morgans technical paper on how this tax will apply.
  • Announced in last year’s 2023 Federal Budget, employers must pay superannuation at the same time they pay salary and wages to employees.

Small Business

  • The instant asset write-off asset threshold of $20,000 will be extended for another year to 30 June 2025.
  • Eligible small businesses will receive $325 in electricity bill relief throughout the year via an electricity rebate.
  • In addition to the instant asset write-off, small and medium businesses switching to energy-efficient equipment or facilities can obtain additional (accelerated) depreciation deductions of 20%.

Cost of Living Relief

  • From 1 July 2024, households will receive a total rebate of $300 on their electricity bills throughout the year.
  • The maximum rates of Commonwealth Rent Assistance will increase by a further 10% over the next five years. This is in addition to the 15% increase delivered in September last year.
  • In response to the Australian Universities Accord, the Government will cap the HELP indexation rate to be the lower of either the Consumer Price Index or the Wage Price Index. This relief will be backdated to 1 June 2023. Changing the calculation of HELP indexation applied from 1 June 2023 means that the indexation rate is reduced from 7.1% to 3.2% in 2023 and from 4.7% to around 4% in 2024.

Aged Care

  • The Government has committed to funding the Fair Work Commission decision to increase award wages for aged care workers. This is on top of $11.3 billion already allocated for the interim 15% increase.
  • The Government will invest $531.4 million to release an additional 24,100 Home Care Packages in 2024–25.
  • The My Aged Care Contact Centre will receive $37 million to reduce call-waiting times for people seeking information and access to aged care.

Welfare Recipients

  • The deeming rates (currently 0.25% and 2.25%) used to assess income under the Income Test for welfare recipients will remain at current levels until 30 June 2025.
  • The government intends to boost assistance for Veterans by providing funding for additional staffing resources and to protect against cyber risk. Funding will also be provided for Veterans’ compensation and rehabilitation legislation.
  • In addition, $48.4 million will be available for Veterans’ Home Care and Community Nursing programs and $10.2 million to provide access to funded medical treatment for ill and injured veterans while their claims for liability are processed.

Paid Parental Leave Scheme

  • From 1 July 2025, superannuation will be paid on the 20 weeks of government-funded parental leave. Parents of babies born on or after 1 July 2025 will receive 12% superannuation on top of their government-funded parental leave.

Working for Women

  • The government is introducing a national strategy to achieve gender equality titled “Working for Women: A Strategy for Gender Equality”.
  • The strategy is intended to drive action on women’s safety, sharing and valuing care, economic equality, women’s health and leadership, representation and decision making.

The Omissions

The wish lists from industry participants were ignored, which as we have come to expect is disappointing but not surprising. No mention of improved tax deductibility on financial advice. Nor any mention of advisers having access to the Australian Tax Office portal to better help their clients. Once again, financial advisers have been left on the bench in relation to easy solutions that can better equip them to support and sustain the financial wealth of Australians.

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