\n\tBy Andrew Nelson<\/p>\n
\n\tIt is again time for us to take our pick of a few important topics that local broker’s covered last week, but with a slight departure this time. Along with a skim of domestic sectors and economic trends, this week we also look at what could be an increasingly important topic, the onset of drought in the US.<\/p>\n
\n\tCanadian industry newsletter Agriweek<\/span> reports the proportion of the US experiencing what are deemed exceptional drought conditions by the US Drought Monitor system have reached the highest level in the history of the program. The report notes that almost 20% of the entire land area of the lower 48 states has now been classified as being under extreme or exceptional drought. What’s worse is that 12% is in the exceptional category. <\/p>\n \n\tGiven the backdrop, last week’s monthly supply-demand report from the US Department of Agriculture was highly anticipated, especially given the deterioration in corn and soybean conditions in the high-production states that were previously holding their own. The report showed that American crops are now far into crop failure territory, with markets sitting on top of a new price plateau.<\/p>\n \n\tCorn yield and crop forecasts were cut by more than 10%, although cuts to demand and use forecasts means there will still be a crop carry-over in a season of a major crop disaster. 2012-13 price estimates were also lifted to a level that is hoped will adequately ration demand. Agriweek<\/span> notes the projected 2012-13 prices add up to corn futures prices pushing past US$7 a bushel.<\/p>\n \n\tAll up, the latest reports point to increasing supply tightness to near-shortage conditions for 2012-13. Agriweek points out that there is a strong tendency for successive USDA monthly yield estimates to continue to decline for the remainder of the growing season when an early trend to lower figures is established. Thus, prices will have to stay high or rise even higher to bring about the type of demand rationing that now seems required, especially given the chance of even worse conditions.<\/p>\n \n\tBack to closer shores, analysts at Morgan Stanley have lowered their outlook for Australian retailers on the back of signs of accelerating deflation last quarter. The broker expects both Woolworths ((WOW)) and Coles ((WES)) to report weaker 4Q like for like sales growth.<\/p>\n \n\tWoolworths boasted prices that were around 11% higher than Coles in the previous period. However, Morgan Stanley notes Woolworths prices were actually 5% lower than Coles across the 4Q11, so higher price deflation for Woolworths is expected to be seen in 4Q12.<\/p>\n \n\tThe good news is the broker expects deflation to ease over the course of this year, with supermarkets to begin cycling over more normalised fresh food prices from next quarter onwards.<\/p>\n \n\tCiti also sees some issues for retailers' floor space issues. The broker notes that while retail share prices have in many cases halved, retailers are as yet to begin rationalising floor space. Citi expects a shakeout is likely over the next three years as cost growth continues to outpace sales growth.<\/p>\n \n\tWhat’s worse, the broker doesn’t expect to see stronger retail demand as being likely to fuel margin recovery any time soon, leaving Citi to think price deflation and online sales will continue to limit bricks and mortar growth. On the broker numbers, non-food retailers will need to cut floor space by 10% or more before margins can begin to recover. The broker thinks such a move would take 3-5 years to play out given lease terms. However, a backdrop of store rationalisation and margin pressure will continue to weigh on share prices amongst retailers.<\/p>\n \n\tCiti believes the stocks that are most vulnerable are Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)) and thus downgraded them both to Sell last week. Few retailers escape the negative prognosis, although the broker points out that some value plays like Billabong ((BBG)) and Specialty Fashion ((SFH)) are already reflecting store rationalisation in their share price. <\/p>\n \n\tMacquarie notes the Chinese government has started to take action to head off weakening conditions, but it wonders will it be enough to reinvigorate commodities demand?<\/p>\n \n\tThe short answer is yes. The broker does think the demand for commodities from infrastructure will be stronger in the second half. Although, Macquarie cautions a broader based recovery will take time given confidence levels are low.<\/p>\n \n\tThus Macquarie sees current issues as being about confidence as much as they are about GDP levels. In fact, the broker thinks forecasted GDP growth of 7.5% for this year will be easily achieved, even without a substantial improvement in economic activity. The broker notes that GDP growth is not an end in itself and that while some data are admittedly weak, there are others that have remained stable.<\/p>\n \n\tAccording to Macquarie, data on employment levels and wage growth actually indicate an economy in good health. Thus, stimulus from Beijing isn’t as urgent as many of us have begun to believe. The broker thinks policy will to continue to be aimed at addressing slowing growth rather than trying to bring about some sort of rapid turnaround in economic activity.<\/p>\n \n\tIn such an environment, the broker likes copper better than iron ore over the next few months given copper is more leveraged to an increase in infrastructure spending, while there is also a distinct lack of copper scrap. That’s not to say Macquarie is turning bearish on iron ore, it simply sees few near term catalysts that could lead to a price breakout. At least not until confidence returns and a broader based recovery takes off.<\/p>\n \n\tLast week saw UBS reaffirm its preference a little towards risk in the materials sector given yield is emerging as a sector share price driver.<\/p>\n \n\tCSR ((CSR)) estimates were cut last week on soft aluminium spot price and weak Australian housing numbers, yet current estimates for Boral ((BLD)) and Fletcher Building ((FBU)) assume an unlikely improvement in end markets with a positive impact from cost cutting over the next two years.<\/p>\n \n\tGiven an Australian housing recovery over the next two years is far from a given and the prospect of both US and NZ recoveries are at best debatable, the broker believes there is less earnings risk in the latter two stocks than in CSR. In fact, even allowing for a decline in the CSR dividend the broker expects a yield of 7.3%.<\/p>\n \n\tOtherwise, only Adelaide Brighton ((ABC)), Fletcher Building and James Hardie ((JHX)) are expected to boast FY14 yields of better than 5%. Boral is below, seeing the broker apply a 20% valuation discount, although keeping it at Buy. CSR and Fletcher are also at Buy, while James Hardie and Adelaide Brighton are at Hold. As you can see, this is far from a negative stance on the sector.<\/p>\n \n\tAll in all, UBS’s notes its recommendations have tended to run opposite to share price performance over the past few years and reflect a bias towards leverage over safety. The sector stance remains risky, however, with Australian and US housing starts needing to improve.<\/p>\n \n\tRBS took a look at major healthcare stocks last week noting that while global uncertainties and FX tailwinds have underpinned outperformance in the sector and will likely continue to lend support going forward, the broker expects to see moderating growth rates, increasing earnings pressure and underwhelming valuations sector wide.<\/p>\n \n\tThe broker last week downgraded Sonic Healthcare ((SHL)) and Ansell ((ANN)) to Hold, given the above along with the risks associated with austerity measures in Europe and lacklustre valuations. However, Ramsay Healthcare ((RHC)) was upgraded to Hold given the belief current trading levels are discounting earnings risk from private health insurance means-testing by far too much.<\/p>\n \n\tRBS sees the most upside in Primary Healthcare ((PRY)) evidence of improving operational metrics and GP productivity, which it notes should help to allay concerns about GP acquisition costs and churn rates. Otherwise, given the risks of unstable global economic conditions, volatile FX and ongoing worldwide regulatory changes, the broker thinks it might be a good idea to opportunistically take profits on any sign of market stabilisation in stocks that have outperformed of late. Ramsay, Resmed ((RMD)) and CSL ((CSL)) are the first stocks that come to the broker’s mind.<\/p>\n