Once-in-a-decade regulatory challenges from a royal commission and lucrative cricket TV rights contract win are among key issues investors must weigh in assessing several key Australian stocks.

Australia’s largest retail-focused bank, Commonwealth Bank (ASX: CBA) has garnered hostile headlines of late. Claims it charged financial planning clients for no service, and even billed clients who’d been dead for years, were among recent revelations aired at the Royal Commission into Financial Services.

But Morningstar’s senior banking analyst David Ellis remains bullish on the fundamentals of CBA and Australia’s other financial industry heavyweights.

CBA, alongside big four rival Westpac (ASX: WBC), is one of the most undervalued of Australia’s financial institutions. CBA is trading at 18 per cent below Morningstar’s fair value estimate (FVE). Westpac is 15 per cent below FVE.

CBA held a 3-star rating--previously a "hold" rating--in January this year, but was upgraded to 4 stars--previously "accumulate"--in March.

Seven hoists batting average

Seven West Media (ASX: SWM) and Foxtel emerged as winners in a carve-up of the television rights to Australian cricket. Nine Entertainment Co (ASX: NEC), meanwhile, sacrificed its 40-year cash cow during the bidding war.

Despite the deal, Morningstar analyst Brian Han’s intrinsic assessment of Seven remains unchanged. Seven was upgraded last month to four-star from three-star.

"In essence, Seven has replaced the current $40 million-per-year tennis rights--lost to Nine from 2020--with the $75 million-per-year cricket rights,” Han says, “with the lift partly justified by the latter’s longer crease-time in the summer schedule.”

"Forecasting the ratings and advertising dollar changes, taking into account the different variations of the new cricket and tennis deals (for example, digital streaming, telecast hours, contra) is a futile exercise, particularly against the structurally challenging backdrop for the industry.”

In fact, Morningstar’s Han argues somewhat of a renaissance is occurring in free-to-air TV as the technology sector grapples with controversies over data privacy breaches.

To that end, Southern Cross Media Group (ASX: SXL) is an attractive opportunity for investors.

Southern Cross Media comprises a regional television operation, metropolitan free-to-air radio operation and a regional radio broadcasting operation. Han points to the reliance of its regional operation, which accounts for 27 per cent of revenue, due to the “stickiness” of local advertisers.

However, it’s worth noting the company’s economic moat is rated “none”, which reflects the proliferation of alternative digital delivery channels, changes in entertainment consumption habits and increasing broadband speeds.

Structural pressures are hampering metropolitan radio operations, compounded by rising content and on-air talent costs. The EBITDA margin from the metropolitan radio division fell from 33.9 per cent in fiscal 2011 to 24.3 per cent in fiscal 2017.

Mortgage Choice a lone survivor in inquiry crossfire

Mortgage Choice (ASX: GMA)--which has no economic moat--weathered the royal commission’s focus on mortgage brokers and maintained its FVE set by Morningstar’s Ellis.

He says it is too early to finalise an outlook for earnings "other than mortgage brokers are unlikely to benefit from the current generous industry structure going forward".

With a share price of $1.70 at publishing time, it is below Ellis’s $2.10 FVE.

Bendigo performs

Also upgraded to four stars, no-moat Bendigo and Adelaide Bank Limited (ASX: BEN).

Morningstar analyst John Likos notes that the bank’s careful expansion of the Community Bank retail franchise and conservative loan growth has boosted performance over the past 10 years.

“We like the conservative management, lower-risk business, steady core earnings growth, industry-leading low bad debts, and the very high customer satisfaction,” Likos says.

“Bendigo’s national branch network, focusing on home loans and retail deposits, is also a plus.”

However, Likos argues that while BEN successfully competes on customer service, it struggles to generate comparable margins because of its much smaller customer base and higher funding and operating costs. And expanding the branch network comes at a cost, and the inflated cost base has weighed on returns.

“Acquisitions have required equity issues, and return on equity, or ROE, has struggled to remain above the cost of capital,” Likos says.

With a FVE of $11.50 per share, the bank’s last closing price at publication was $10.10.

Auckland airport takes off

Morningstar analyst Adam Fleck sees good opportunities for Auckland International Airport Limited (ASX: AIA) to expand its commercial property portfolio by using its massive land bank.

“Pent-up demand from multinational firms involved in freight, logistics, and transportation businesses should spur developmental activity, and this should in turn drive rental growth,” Fleck said.

“Similarly, the airport continues to invest its retail footprint, and when combined with a further growth in the number of high-spending Asian tourists who desire to visit duty-free retail stores, we expect a significant lift to retail revenue over time.”

Fleck notes the company’s route-development strategy has boosted seat capacity into and out of Auckland by more than 4 million passengers (net of losses) since fiscal 2014.

“This bodes well for both aeronautical and retail income. Management sees immense opportunities from Asia, particularly China and India, and is wooing airlines to commence new services to Auckland,” he says.

But risks remain. A slowdown in global economic conditions, particularly in China, could affect tourist inflow to New Zealand, limiting both per-passenger fees and retail spending at the airport, and the New Zealand domestic market could face tepid passenger growth, given high consumer debt levels.

Fleck is encouraged that management has generally opted to structure its capital investments to increase flexibility in the event of lower traffic, which in turn lowers the risk of medium-term overcapacity.

 

More from Morningstar

• CBA gold medal fundamentals outweigh the headlines

• Banks stocks to survive Royal Commission hit

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

Brian Colello, CPA, is a senior equity analyst for Morningstar, based in the US.

Glenn Freeman is a senior editor with Morningstar, based in Sydney.

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