Morningstar Equities Research

Morningstar Equities Research - CGF, ANZ, COH, SGP, BRG, ALZ, VCT-NZ, POT-NZ, LEP and QBE, QAN, IVC, NVT, SGP, TRS on price change

Challenger Limited CGF| Continuous Cuts to the Aged Pension Support Demand for Challenger's Income-Focused Products

Morningstar Recommendation: Hold
Nathan Zaia, Morningstar Analyst -
Challenger's business update focused on positive industry tailwinds which support long-term growth in demand of retirement income products, and how by leveraging its trusted brand continues to dominate and grow the Australian annuity market. The recent federal government budget focused on spending cuts, at the heart of which is addressing long term projections of an overwhelmingly unsustainable pension burden. The government continues to increase the age at which superannuation can be accessed and the pension age, as well as leaving the door open to changes in pension asset tests. A change in the weighting of superannuation portfolios to fixed income and annuity style products is a likely response to the increasing emphasis and burden on the public to build reliable income streams in retirement. Challenger's successful and proactive marketing campaign to attract and educate the public is already attracting increasingly strong inflows to its life annuity products.

Management expects fiscal 2014 retail annuity growth and operating earnings to be at the top-end of guidance. Our fair value estimate is unchanged at AUD 6.50, and at current prices, its shares remain fairly valued. A favorable outlook for Challenger is underpinned by an increasing number of superannuation investors and self-funded retirees seeking secure retirement incomes, and compulsory superannuation growing the size of the market. Challenger benefits from a strong brand name and distribution channels, but unlike other fund managers who benefit from a relatively sticky customer base, annuity products generally have a fixed life. The inherent risk of the business model also weighs in on our no-moat rating. Unlike other asset managers, Challenger must take on investment risk to provide clients a margin over the bond rate, as well as make an acceptable return for the firm. Miscalculating this risk, or severe economic shocks, could result in capital destruction.

Australia & New Zealand Banking Group Ltd ANZ| ANZ Bank's Exemplary Stewardship Upgrade Underpins Positive Outlook

Morningstar Recommendation: Accumulate
David Ellis, Morningstar Analyst -
Wide-moat rated Australian and New Zealand Banking Group, or ANZ Bank, is our preferred Australian major bank, with attractive long-term growth prospects based on its differentiated Asia growth strategy and attractive forecast shareholder returns. Solid business and consumer growth continues to boost earnings and returns on equity. We upgrade our stewardship rating of shareholder capital to Exemplary from Standard, reflecting ANZ Bank's impressive focus on increasing shareholder returns and successful execution of strategy. A key catalyst for price rerating is further confirmation on the success of the push into Asia. ANZ Bank's biannual investor presentation in Hong Kong in July will present a clearer understanding of progress across Asia, but in the meantime we are increasingly confident the group's growth strategy is on track to produce sold profit growth in the medium to long term. The strategy is to become a "super-regional" bank in Asia, with the central objective to source 25% to 30% of earnings from Asia by 2017, while also growing the core domestic businesses in Australia and New Zealand. Asia currently accounts for about 20% of group cash profits. This differentiates ANZ Bank from its domestic peers, none of which has a strategy centred on Asia.

Investment decisions have furthered the bank's Asian ambitions and, importantly, expanding in Asia enables ANZ Bank to strengthen and broaden customer relationships as an increasing number of customers are doing business across the Asia-Pacific region. Successful implementation of the strategy increases competitive advantages and widens the moat. Despite the 16% increase in share price since early February, the stock remains undervalued, trading at a 14% discount to our AUD 39.00 fair value estimate. The growth strategy is delivering impressive results with all businesses contributing to the high-quality performance. There is no indication ANZ Bank's Exemplary capital stewardship is likely to change anytime soon.

Cochlear Limited COH| Cochlear relaunches Nucleus C1500 Series: Raising Fair Value Estimate

Morningstar Recommendation: Hold
Chris Kallos, Morningstar Analyst -
Cochlear will relaunch its Nucleus C1500 series of cochlear implants, the Nucleus Profile, after voluntarily recalling the product from the market in September 2011 owing to concerns related to malfunction of specific electronic components. The company will launch the Nucleus Profile across Europe later this month. The new system contains the Contour Advance Electrode (C1512), the thinnest implant body on the market, which will support a wider range of surgical techniques. The product has been approved by TUV Rheinland, a global provider of certification services, and should be rolled out into other geographies pending regulatory approval. Cochlear has flagged the introduction of other electrodes onto the series over coming months. This follows the recent FDA approval of the Nucleus Hybrid L24 cochlear implant system, which combined acoustic amplification of low frequencies with the electrical stimulation of high frequencies in one device.

Cochlear has a narrow moat and a stable moat trend with medium uncertainty. Our fair value estimate moves to AUD 57.00 from AUD 55.00 per share, to reflect the growing product offering and potential to regain revenue growth momentum achieved prior to its product recall in 2011. At AUD 59.00, the stock is trading broadly in line with our fair value estimate. Cochlear dominates the cochlear implant market, and despite recent encouraging results from Advance Bionics (Sonova), remains the innovation leader in novel technologies. Current research, linking hearing loss with cognitive decline in the elderly, bodes well for increasing penetration of the adult market.

Stockland SGP| Stockland Outbid in Its Scrip Offer for Australand

Morningstar Recommendation: Reduce
Tony Sherlock, Morningstar Analyst -
Singapore-listed Frasers Centrepoint has trumped Stockland's mostly scrip-based takeover offer for Australand. Frasers' all cash offer is AUD 4.48 per Australand security, with Australand securityholders also entitled to retain the expected first-half 2014 dividend of AUD 0.1275. The ex-dividend date is typically late June. The Australand board considers the offer superior to Stockland's bid and has extended Frasers a four week period of exclusive due diligence. The Frasers offer contains a number of conditions, which we anticipate will be met. These include a minimum acceptance condition of 50.1% and approval from the Foreign Investment Review Board.

Under-bidder Stockland has advised it is considering its options and will provide an update in due course. We don't expect Stockland will raise its offer further, as to do so would diminish the indicative 5% earnings accretion, marginalising the merits of a merger. Also, Stockland had stated its revised takeover offer of 1.124 Stockland securities per Australand security was final. Frasers' period of exclusive due diligence temporarily knocks Stockland off the negotiating table. Stockland was previously granted permission to conduct due diligence, but Frasers' exclusive due diligence means this must be withdrawn.

We consider Frasers' AUD 4.48 offer as a full price, representing a 15% premium to our AUD 3.90 fair value estimate for Australand. We have recommended Australand securityholders accept Frasers' offer in the absence of a superior offer.

If Stockland had been successful in its takeover of Australand it would have fast-tracked aspects of its strategy, such as its desire to increase its exposure to industrial property and undertake low-level apartment developments in inner-city locations. We don't see an the inability to acquire Australand as derailing this strategy, rather it results in a more orderly and measured execution.

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