Weekly, Costa | ANZ | MQG | Amazon

3 November 2019

Weekly Report

Here’s your weekly update of news, analysis and research. The full reports can be read on the stock pages.

COSTA GROUP (CGC:AX) BUY (High Risk): Bottom of a Cycle?
CGC shares fell heavily again, after returning from a six-day trading halt revealing its third earnings downgrade for the year. Another deterioration in trading and growing conditions led Costa to raise A$176m in new equity through a rights issue, to shore up its balance sheet and pay down debt in order to ride through an extended downturn. Earnings expectations for the year ahead have approximately been halved, as a further deterioration relative to the August trading update was driven by late season citrus, as yields dropped off due to drought weather conditions. Other major impacts included low berry pricing due to persistent NSW oversupply and mushroom prices that remain depressed. Spot water prices are also to blame which could be set to get worse as drought conditions persist longer than initially anticipated. This disappointing news again highlights that companies like Costa, despite their risk mitigating efforts, aren’t immune to shorter-term agricultural and seasonal risks affecting yields, volumes and pricing. A “silver lining” being that despite the many difficulties, Costa are still able to deliver a profit. While it is notoriously difficult to predict the weather/drought, we note that 7/9 of Costa’s produce categories are facing headwinds – which is surely not a “normal year”. How many issues will normalise and how many will persist for the year ahead remains the key question. However, taking a medium term view we still believe the company can recover once the operating backdrop improves.

ANZ BANK (ANZ:AX / ANZ:NZ) BUY: Franking Cut
ANZ shares fell on a weaker than expected result for the 2019 financial year, despite maintaining dividends flat at 160 cents per share ANZ’s surprise decision to partly frank (resulting in a lower after-tax dividend for shareholders) its final dividend was not well-received. ANZ delivered a cash profit from continuing operations of $6.47 billion, which was flat on the prior corresponding period and fell short of the market’s expectations.
Margin decline from lower interest rates was higher than expected, and regulatory costs remain elevated,
while customers are also paying-down mortgage debt under lower rates and locking in lower fixed rates. These headwinds were partially offset by increased loan book, higher institutional banking profit and lower operating expenses. Unfortunately, ANZ faces another difficult year ahead with revenue growth not a given, since low rates and competition are likely to further impact margin – in an environment where credit growth is tightening in a slowing and risk adverse economy. The key risk for the Banks remains the property market, but we believe the property market has now bottomed, and in any case ANZ looks less exposed given their portfolio is shifting towards lower risk loans. ANZ continues to be our preferred pick of the big 4 Aussie Banks

because of its strong capital position, restructuring initiatives, lower risk profile, cost cuts to maintain profit, and a relatively healthy dividend – (even if it were to cut slightly over the near-term).

MACQUARIE GROUP (MQG:AX) Buy (High-Risk): Guidance Unchanged
Shares in Macquarie were flat as it posted a sound result for the first half of the 2019 financial year, where it increased its net profit after tax by +11% to A$1,457m for the 2019 financial year. Macquarie maintained previous guidance for their 2020 financial year that net profit after tax will be “slightly down” on 2019 – with the market expecting a guidance upgrade. 2019 was an exceptionally strong result thanks to a stellar second half performance from its commodities and global markets divisions, helping deliver a full year net profit after tax of A$2,982m (up +17% from the previous year) which Macquarie believe will be difficult to replicate again in 2020. The first half result was driven by a strong performance from the annuity style businesses (particularly Macquarie Asset Management) generating 60% of group profit and provided a combined net profit contribution of A$1,717m, which was up +15% from the same corresponding period last year – and up +11%
from the previous half (2019 second half). Offsetting weak profit contributions from Macquarie Capital
business which suffered from lower activity compared to a significantly higher level of activity in the previous year, and rising costs associated with increased headcount and investment into technology. With growing concerns following the developing headwinds facing the mortgage market in Australia (and New Zealand) Macquarie offers a more diversified income stream over the big 4 Aussie Banks, both regionally (with 66% of income earned globally) and varied product offering – with a balance between stable annuity style earnings as well as its volatile capital markets facing businesses. For this reason, we believe Macquarie offers a more attractive risk/return proposition relative to the big 4 Aussie banks who are highly exposed to the headwinds facing the mortgage market, in our view.

Amazon (AMZN:NASDAQ) HOLD: Revenue Growth Hurts Profit
Amazon delivered weaker than expected earnings for the 2019 third quarter and tepid guidance for the fourth quarter. The third quarter included full adoption of the new one-day free delivery service for prime customers, which helped boosted revenue to $69.89 billion up +23.7% from last year. However, net income after tax fell -26% from last year down to $2.13 billion or $4.23 per share, missing market expectations by 26 cents per share. The increased costs and investments associated with the new service being significantly larger than previously anticipated which weakened margins, as Amazon invests heavily to drive future top line growth – reversing the recent trend of margin improvement before the one-day free delivery service was implemented. This is not a new approach, with Amazon continuing its long-term practice of sacrificing profits when it sees

opportunities to improve service to its customers, growing top-line revenue aggressively, to later focus
widening margins with bigger scale. Accordingly, fourth quarter earnings are also expected to be lower than a year ago, while revenue growth also appears to be moderating with +11% to +20% revenue growth guided – below market expectations. Because Amazon operates many businesses it is difficult to grasp how to value it, also the stock is still priced for expansive growth, with heavy investment into new services now weakening margins over the short-term to achieve top-line growth – which is an embedded expectation.
We continue to believe Amazon is a great company and they will continue to grow and expand, although given its size their growth rate will continue but at a more moderate rate. We believe Amazon will continue to grow from strength to strength over the long-term, but with its share price more prone to market sentiment near term – for that reason we remain HOLD rated given its current valuation.

03-Nov-19

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