Ords Ord Minnett Research "The current financial year looks much brighter, with every sector likely to experience higher profits"

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1 Ords Monthly EARNINGS SEASON WHAT MATTERS MOST Ord Minnett Research February 2017 "The current financial year looks much brighter, with every sector likely to experience higher profits" For the first time in a long while, earnings for the Australian market appear as though they will be higher this financial year than in the previous one. Corporate profits look set to grow by 11%, according to consensus estimates. In the last five years, companies have had difficulty generating profit growth, with aggregate declines in four of those years. The only exception was a 5.6% expansion in The 2016 financial year was the worst contraction since the financial crisis, falling 13%. In that year, only S&P/ASX 200 Index & EPS Integer ASX 200 Index 7,000 6,000 5,000 4,000 3,000 2,000 1,000 four out of the 11 major sectors had profit increases: consumer discretionary, industrials, IT and utilities. In contrast, the resource sectors saw the largest declines, but other major sectors, such as banks and consumer staples, also saw profits go down. Thankfully, the current financial year looks much brighter, with every sector likely to experience higher profits. Importantly for the February reporting season, there appears to be some momentum behind profit forecasts, with most sectors seeing ASX 200 EPS Integer 0 $ Financial year Source: Ord Minnett Research, Thomson Reuters. FY17 ASX 200 Index measure of 5,692 is at 19-Jan-17. $400 $350 $300 $250 $200 $150 $100 $50 Earnings per share integer forecast upgrades over the last six months. The most notable of these being the resource-heavy materials and energy sectors. One area seeing some slippage is consumer companies. The importance of earnings cannot be overstated. There is a fundamental relationship between profitability and the value of shares, as evidenced by the chart below. In order for a stock market to sustain movements higher, companies within that market need to be able to consistently grow profits. It would appear that the Australian market is back on track. Changes in FY17 profit forecasts Sector Change in profit growth forecast over last 6 months (percentage point) S&P/ASX Cons. Discretionary -4.4 Cons. Staples -0.1 Energy +5.7 Financials -0.7 Banks +1.1 Health Care -6.2 Industrials +1.5 IT -1.6 Materials Property 0.1 Telcos 4.1 Utilities 2.2 Source: Thomson Reuters. Changes since 30 June 16

2 INVESTMENT STRATEGY THE CHARGING BULL After a strong rally in November and December, the market has steadied in recent weeks. The improvement in global stock markets has come on the back of broadly better economic news offshore and the prospects for fiscal stimulus in the US. Buoyant global growth, together with continued accommodative monetary policy in Australia, should support market multiples. The ASX 200 Index, however, is already closing in on 5,800, the top end of our 2017 forecast market range. Despite earnings estimates improving, as discussed on Page 1, there are some arguments for a period of consolidation in the near term. Investment Strategy 2 The charging bull Caltex & Woolworths 4 Fuelling around Woodside Petroleum 5 Hit the gas Suncorp 6 Cloudy skies clearing Regis Resources 7 Golden years CSL Limited 8 Pick me up A number of event-risks met in recent weeks Late last year, we identified a checklist of items that, in our view, need to be fulfilled in order for markets to break out. A fair few (but not all!) have been tackled in the last few weeks. These items include greater clarity around monetary policy from central banks in the interim; reduced political gridlock in the US which could make policy more effective; and good momentum on a number of economic indicators which supports a stronger earnings outlook. There is also easing nervousness towards global banks as interest rates rise; as Deutsche Bank negotiates a lower settlement amount with the US Department of Justice; and as regulatory risks subside. But a period of consolidation may be due in the near term given several factors: 1) Investors are now net bullish The American Association of Individual Investors (AAII) surveys its members weekly for their view on the direction of markets in the next six months. Using the results from the survey, we can calculate the bull-bear spread (the difference between the percentage of bullish and bearish investors in the US). In the last two months, the spread has turned positive. Investors have moved from net bearish to net bullish. However, traditionally this survey has been used as a contrarian indicator, i.e. higher levels of investor optimism tend to signal more muted returns from the market ahead, and vice versa. If the current bullishness extends, then there is more reason for cautiousness on forward returns. To the extent that the Australian market is influenced by the performance of US equities, this signal is worth watching. 2) Markets have outpaced changes to the growth outlook Equity markets have, in part, rallied on prospects that fiscal stimulus in the US will boost growth. But with a vacuum of detail, economists initially moved their global growth forecasts only moderately higher, on average between % in 2017 and 2018, as higher growth estimates for the US were offset by downgrades for emerging markets. Rising trade tensions that may accompany the new US administration mean many economists feel the risks around the potential growth outcomes have widened. Yet investors, consumers, and manufacturing surveys have reflected more optimism, with sentiment indicators in each category, e.g. AAII Bull Bear, consumer confidence, global PMIs, rising notably. The pace of economic surprises has therefore been increasingly positive. This optimism could become selffulfilling but is also at risk of disappointment, especially if stimulus from Trump s policies fails to deliver the expected boost, or if the tightening of

3 Ords Monthly February financial conditions from accelerated Federal Reserve rate rises, higher bond yields and a higher US dollar dulls the upside. The pace of economic surprises looks like it is nearing another short-term peak. 3) Australia yet to build conviction The strength in the Australian stockmarket, up circa 10% since the US election, has come despite uninspiring economic data locally (Figure 1). Employment growth is sub-1%, September-quarter GDP fell 0.5%, building approvals are down 12% on the three-month annual rate, and wages growth is at a record low, while consumer and business confidence are below average. Despite this backdrop, earnings have been revised higher. The upgrades to earnings, however, are mostly centred on the resource sector (on the back of higher commodity price forecasts), with some milder improvements in other sectors. The upcoming company results season in February will highlight strengths and weaknesses in the non-resources segment of the economy. 4) Commodity price gains appear vulnerable In particular, we refer to iron ore and coal, where the next few weeks pose a seasonally quieter period for Chinese demand due to the onset of winter and the Lunar New Year. Price gains have recently started to stall or correct (Figure 2). A moderation in commodity prices is not unexpected. In fact, the consensus view currently forecasts a softening in these commodities through 2017 as supply returns. As spot prices converge back towards analyst estimates, the likelihood of substantial upgrades to earnings estimates in the resources sector (which have been a key driver of more upbeat earnings estimates for the market recently), should diminish. Furthermore, upcoming events which could pose catalysts for some profit-taking include management tone during the US Decemberquarter earnings season (in progress); any hawkish rhetoric from major central bank meetings; details of Trump s actual policies; OPEC s progress on the oil production cuts; and earnings confessions in Australia ahead of and during reporting season in February. Who s jumped the gun? A few companies have performed exceedingly well since the US election, despite modest expectations about their growth prospects. We highlight stocks which we rate Hold, Lighten or Sell, but which have outperformed the broader market and are now trading 10% or more above our price targets. Within financials, Bendigo & Adelaide Bank (Lighten) now sits over 25% above our target price. Our first preference within the sector is ANZ. QBE Insurance (Lighten) is experiencing some benefit from rising US interest rates, but we believe stock-specific issues will continue to weigh on its margins. Metcash (Hold) clearly exceeds our $2.00 price target, but we believe Wesfarmers has a more solid business with greater potential. The share price of Ardent Leisure (Hold) fell sharply last year after the tragic incident at its Dreamworld leisure park, however, it is still trading above our target price. Our preferences in the leisure sector are Event Hospitality and Sealink. Figure 1: Employment and retail sales growth slowdown among the headwinds in Australia 7% 6% 5% Retail Sales Employment Figure 2: Hard coking coal and iron ore price gains stalling Iron Ore (LHS) Coking Coal YoY 4% 3% 2% 1% US$/t US$/t 0% Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Monthly Source: Thomson Reuters 40 0 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Weekly Source: Bloomberg

4 CALTEX & WOOLWORTHS FUELLING AROUND Woolworths has entered into a binding agreement with BP to sell its petrol business, comprising 527 Woolworths-operated fuel sites and 16 development sites, for $1.785 billion. Woolworths indicated it would use the sale proceeds to strengthen its balance sheet and reinvest in its core businesses. Deal completion is not expected until January 2018 and is subject to ACCC and FIRB approval. For Caltex Australia, which currently co-brands 132 petrol stations with Woolworths, the earnings impact from the loss of petrol volumes is significant. Fuel margins will shrink with lower volumes, while sales at sites accepting Woolworths discount vouchers will also drop. Recent acquisitions by Caltex (Milemaker and Gull NZ) will help to ease the impact, but we still expect to see earnings per share drop when the business is sold. This leads us to lower our Caltex price target to $27.00, which reflects the loss of volumes now being a probability, not a possibility. Given the share price does not reflect the new situation, we reaffirm our Lighten recommendation. Woolworths and BP intend to enter into a strategic partnership with a number of features. BP has 350 company-operated sites and 1,400 BP-branded fuel and convenience sites. Woolworths indicates that this will result in around 80% of Woolworths supermarkets now sitting in close proximity to a fuel site, up from 75% currently. Convenience offer under the Metro format: A pilot of Metro at BP, a brand of convenience supermarkets, will be undertaken in 16 stores, funded by both parties. If successful, BP and Woolworths will then enter into a long-term arrangement, funded by BP and supplied by Woolworths, that will see up to 200 BP convenience stores refurbished in a Metro at BP format with a focus on the food-on-the-go offering being developed at Metro and its Woolworths supermarkets. Woolworths Rewards to be broadened: BP will become a cornerstone partner in Woolworths Rewards, which features Qantas Frequent Flyer points. Once established, this will allow points to be earned and redeemed on fuel and convenience at BP sites. Considering the broader impact on Woolworths, we see this deal as likely to be dilutive to earnings per share in the 2019 financial year but the reduction in balance sheet gearing from the sale proceeds is the key issue. Surplus capital will be reinvested, arguably to fund and possibly accelerate supermarket store renewals. There is obvious risk around the ACCC approving the deal given the combined market share of BP and Woolworths petrol business was 37% in We expect divestments will have to be made, although few are likely to be sold to Caltex. There is potential around the new convenience format, but execution risk is high (the format is unproven, it lacks scale and implementation costs will be high). We recently upgraded our Woolworths recommendation to Accumulate with greater confidence that a sustainable turnaround in the Food business is occurring. Price investment has occurred, in-store execution has improved (labour, shrinkage, product availability), marketing and loyalty are no longer damaging the business, and there is evidence of cultural change. Balance sheet pressures are also easing with the turnaround and the Petrol sale. Fuel redemption offer to be maintained and extended: Woolworths and BP will equally fund the 4 cents discount per litre (provided a consumer spends over $30 in a single shop at Woolworths supermarkets). The discount offer will be maintained at the 527 Woolworths petrol sites and be extended to selected BP sites, while BP has agreed to offer a base points-per-dollar Woolworths Rewards points on in-store merchandise and pointsper-litre on fuel purchases. 2016A 2017E 2018E CTX ($29.86) Profit after tax ($m) Price/Earnings (x) Dividend Yield (%) WOW ($24.38) Profit after tax ($m) 1,621 1,556 1,748 Price/Earnings (x) Dividend Yield (%) Source: Ord Minnett Research. CTX 2018 estimates include assumption of loss of WOW petrol volumes adjusted for recent acquisitions.

5 Ords Monthly February WOODSIDE PETROLEUM HIT THE GAS Sector: Energy Recommendation: Accumulate Risk rating: Higher Share price: $31.95 Year to December 2016E 2017E 2018E Profit after tax ($m) 1,085 1,395 1,556 Woodside Petroleum (WPL) share price 35 Earnings per share ($) Price/Earnings (x) Dividend ($) $ Dividend Yield (%) Jan-16 Apr-16 Jul-16 Oct-16 Weekly Jan-17 Source: Company report, Ord Minnett Research. Profits are on a normalised basis. Source: IRESS Woodside is an Australian oil and gas company involved in hydrocarbon exploration, evaluation, development, production and marketing. The company has a portfolio of offshore platforms, oil floating production storage and off-loading vessels. Its operating assets are situated in Australia and overseas. An announcement in March last year that the Browse floating LNG project had been put on hold seemed to galvanise the market s view that Woodside lacked viable growth options. Management, however, has continued to build the company s growth pipeline, including acquiring acreage in Senegal and developing resources in Myanmar. Our analysis of Woodside s growth opportunities shows that attributable production could grow by 25% to mmboe in We estimate the value of unsanctioned growth projects, including Senegal, Kitimat (Canada) and Browse (offshore Western Australia), to be ~US$14 billion or ~US$4 billion (A$6.50/share) on a risk-adjusted basis. This value excludes north-west shelf plateau extensions (which we value at US$1.4 billion and include in our base-case valuation). Near-term growth is expected to be more liquids-focused with Greater Enfield (2019) and the unsanctioned deep-water Senegal project (estimated 2022) the first projects to come online. Longer-term targets are large-scale LNG projects such as Kitimat and Browse, which are likely to be more than a decade from first production. If we assume all the projects are sanctioned, we estimate Woodside s share of capital expenditure to average ~US$2 billion a year to This is broadly in line with 2016 capital expenditure guidance, which includes the Wheatstone project in Western Australia. We believe Woodside management has done a commendable job of addressing two key issues. Firstly, the company has signed near-term LNG contracts covering 85% of production. More importantly, management has acquired a number of options for growth. We acknowledge that the sale of Shell s remaining stake in Woodside could be a headwind. Shell recategorised its 13% stake as an asset held for sale in its latest accounts, so the overhang could weigh on the stock. Nonetheless, our analysis provides us comfort that Woodside has growth within its portfolio and that the stock has valuation upside after adjusting for the risk-weighted value of these growth opportunities. As a result, we upgraded our recommendation to Accumulate. Further project development could crystallise the value of Woodside growth and act as a catalyst for the stock. We would also note that earnings are expected to grow ~40% in 2017 and 2018, underpinned by stronger pricing and Wheatstone coming online.

6 SUNCORP CLOUDY SKIES CLEARING Sector: Financials Recommendation: Accumulate Risk rating: Higher Share price: $13.35 Year to June 2016A 2017E 2018E Profit after tax ($m) 1,097 1,133 1,298 Suncorp (SUN) share price 14 Earnings per share ($) Price/Earnings (x) Dividend ($) $ Dividend Yield (%) Jan-16 Apr-16 Jul-16 Oct-16 Weekly Jan-17 Source: Company report, Ord Minnett Research. Profits are on a normalised basis. Source: IRESS Suncorp is a Queensland-based financial services conglomerate offering general insurance, life insurance, retail and business banking, superannuation and investment products in Australia and New Zealand. Suncorp has five core businesses: Personal Insurance, Commercial Insurance, Suncorp Life, Suncorp Bank and Vero New Zealand, Ahead of its interim result, Suncorp provided an update on the costs of claims associated with natural perils, reserve strengthening for the 2010 and 2011 Canterbury earthquakes, and the disposal of its New Zealand Autosure motor insurance business. Natural hazard slightly above allowance for first-half FY17 Suncorp reported that natural hazard claims costs will be $40 million above its half year allowance of $310 million ($620 million allowance for the full year). We note the six months to 31 December 2016 experienced quite a few catastrophe events. Suncorp s $350 million of natural hazard claims includes NZ$50 million for the net impact of the Kaikoura earthquake in November 2016, $60 million for storms in South Australia and Victoria in November 2016 and $50 million for storms in the same states in December Suncorp has historically been a little more aggressive than IAG in its allowances, but we think the company has moved to address much of this. They have strengthened their aggregate cover for 2017 although to date it doesn't seem to have helped the results this half. Reserve strengthening for 2010/11 Canterbury earthquakes Gross outstanding claims provisions for the 2010/11 events increased $112 million due to new over-cap claims, resulting in incurred net cost of NZ$18 million, which will impact the first-half FY17 result. Suncorp had previously conducted a review of over-cap claims, but it appears once again that there is some upward revision, perhaps due to increases from additional repairs needed on previously under-cap claims. The net amounts are small due to reinsurance, although there is a risk that any further increases will erode reinsurance layers that are less well-covered. Disposal of New Zealand Autosure motor insurance business The sale of the Autosure motor insurance business to Turners Ltd resulted in a $25 million non-cash post-tax loss but will release $30 million of capital. This transaction will be accretive to the NZ business s long-term return on equity. Despite this news around higher claims costs, we retain a positive view of Suncorp as we believe it will benefit from positive trends in the insurance cycle in Australia. Having rebased expectations to 10% underlying margins 12 months ago, we believe Suncorp will experience rising underlying margins going forward. This will largely be driven by unilateral pricing changes by Suncorp, a favourable cycle in commercial, and improvement in claims method. Our preference is for domestic insurers over insurers with international exposure given a more favourable pricing environment here. The stock also currently trades cheaper than peers on a price/earnings basis.

7 Ords Monthly February REGIS RESOURCES GOLDEN YEARS Sector: Financials Recommendation: Accumulate Risk rating: Higher Share price: $3.22 Year to June 2016A 2017E 2018E Profit after tax ($m) Regis Resources (RRL) share price 5 Earnings per share ($) Price/Earnings (x) Dividend ($) $ 4 3 Dividend Yield (%) Jan-16 Apr-16 Jul-16 Oct-16 Weekly Jan-17 Source: Company report, Ord Minnett Research. Profits are on a normalised basis. Source: IRESS Regis Resources is a purely Australian gold miner, with operations at the Duketon Gold Project in the North Eastern Goldfields of Western Australia and the McPhillamys Gold Project in the Central Western region of New South Wales. The company has a pipeline of organic growth options delivering attractive annualised production growth over the next three years as higher-grade satellite pits boost both annual production rates and mine life. A strong December-quarter production report contained several key takeaways: Production above and costs below our forecasts Production of 80,000oz was 2% ahead of our 79,000oz forecast and up 7% on the September quarter. All-in sustaining costs of $951/oz were 4% below our forecast due to lower-than-expected capital expenditure. Company guidance for annual production is unchanged at ,000oz at a cost of $980-1,050/oz. The cost outlook is favourable as the strip ratio is expected to drop in the coming quarters. Integration of higher-grade satellite pits into the mine plan is encouraging Higher-grade satellite ore bodies, including Gloster and Erlistoun in WA, are expected to displace lower-grade ore in the medium-term production profile, which will be positive for production rates and operating costs. Cash balance topped our expectation by $16 million, driven by better operating cash flow Operating cash flow of $64.5 million was $9 million ahead of our $55.3 million forecast and the primary driver of the cash level reaching $130 million against our $114 million estimate Following the production report, we updated our forecasts with the key change an improved near-term grade profile, which positively impacts both production and costs. Our price target also jumped to $4.00. ASX-listed gold companies have historically been poor allocators of capital, but we believe Regis sector-leading capital management represents a compelling investment advantage. The company has expressed a desire to pay out excess cash, with our 50% dividend payout estimate potentially conservative. Regis remains our preferred ASX gold exposure given attractive dividend yields for the next three years, a pipeline of organic growth options delivering around 6% annualised production growth and an attractive free cash flow yield of 10 13%.

8 Ords Monthly February CSL LIMITED PICK ME UP Sector: Healthcare Recommendation: Accumulate Risk rating: Medium Share price: $ CSL is a biopharmaceutical company that researches, develops, manufactures and markets products to treat and prevent human medical conditions. These conditions include coagulation disorders, viral and bacterial diseases, bleeding disorders and other diseases. CSL has manufacturing operations in Australia, Germany, Switzerland, the UK and the US. In mid-january, the company announced a profit upgrade that caught the market off-guard the stock ralling 12.5% on the day of the announcement. CSL s strategy of aggressively investing in capacity at blood collection centres and fractionation facilities allowed it to take advantage of competitor supply issues. We believe the lack of investment in collection infrastructure by competitors should allow CSL to enjoy above-market growth from its core plasma operations for at least a further 18 months. CSL guided to net profit of US$800 million for the first half of the 2017 financial year, up 35% on a year ago, but which implies only circa 10% underlying growth in the second half. Considering the profit upgrade reflects supply issues with competitors, a portion of which are likely structural, we see upside to CSL's full-year estimates. Indeed, this market share gain underpins material upgrades we have made to forecasts. CSL is now likely to deliver two years of over 20% earnings growth and the potential for further earning upgrades if recent share gains can be maintained. Accordingly, we boosted our target price to $120 and reinstated an Accumulate recommendation on the stock. CSL s core business remains robust and new product releases could also provide upside for sales. While the turnaround of the Novartis flu vaccine business that it acquired recently has a degree of execution risk, it also has the ability to significantly boost earnings in the years ahead. 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