The Wrap: Cars, Coal, Copper And Inflation

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Weekly Broker Wrap: Automotive dealer commissions; China's coal policy; Citi bullish on copper; ANZ Bank researchers' new inflation indicator.

-Proposed cap on add-on insurance commissions for car dealerships rejected by ACCC
-But reduced incentives considered still likely in the longer term
-Why would the Chinese government roll out the 276-day coal policy again?
-Copper supply expected to underperform demand
-RBA's cash rate expected to remain at 1.5% for the near future
 

By Eva Brocklehurst

Automotive Dealers

The financial regulator ASIC's report last September found that add-on insurance products offered by car dealerships provided little or no value for consumers. Responding to the findings in the report, the Insurance Council of Australia announced it intends to impose a 20% cap on commissions paid to motor vehicle dealers, starting July 1, 2017. Average commissions currently range from 20-50% on these products.

However, the consumer watchdog, the ACCC, intends to reject this proposal and, while agreeing with the ASIC findings, considers the proposed cap unlikely to result in a public benefit. The ACCC believes a reduced cap on commissions does not remove the incentive for insurers and dealerships to sell consumers these more expensive products.

Believing a cap on flex commissions in terms of dealer finance is still likely, Moelis incorporates a 1.5% cap in its analysis. Given that ASIC has now indicated it is more open to industry discussions this also raises the possibility of a higher cap than the broker is factoring in.

Should a 1.5% cap on flex commissions be implemented, after management acts to mitigate the downside, Moelis expects a -5-10% hit to automotive earnings. Nevertheless, even after adjusting for the impact, the broker believes both Automotive Holdings ((AHG)) and AP Eagers ((APE)) are trading at attractive multiples.

The ACCC's objection may reduce the probability of lower commissions in the short term, but Morgan Stanley believes ASIC is still intent on removing the incentive for insurers and dealerships to sell these poor value products. The broker also suspects any changes will take longer to execute. Morgan Stanley maintains a view that revenue for the likes of Automotive Holdings and AP Eagers is at risk, but this is less likely to come from an immediate cap on commissions.

Coal

China's government is apparently considering resuming its controversial policy of limiting the coal industry's operating days to 276, versus the normal rate of 330 days. Morgan Stanley observes coal equities have lifted on the speculation, probably expecting another surge in the coal price similar to what occurred last year. The broker believes this is an odd response.

As the Chinese government was alarmed at how the policy affected coal supply and the price spike, why would it roll that out again? The government's reform program poses the biggest risk to the broker's coal forecasts but, given the 276-day policy was reversed in 2016, a more moderate strategy for 2017 is expected, with limited upside risk for prices.

Morgan Stanley forecasts US$74/t FOB for thermal coal prices in 2017, based on a 40mt deficit for this trade. Conversely, metallurgical coal is seen closer closer to balance and product prices have fallen 32-50% since November. Morgan Stanley forecasts spot coking coal prices of US$183/t for 2017.

Copper

Citi maintains a bullish view on copper, expecting supply to underperform demand, which could push peak prices to over US$8000/t before the end of the decade. Chinese demand growth of 3-4% in 2017 is stacked against weaker-than-expected supply, which has been affected by capital expenditure reductions.

The broker's base case includes an 8.3% upgrade for 2017 copper prices and 5.8% for 2018. Both OZ Minerals ((OZL)) and Sandfire Resources ((SFR)) have witnessed an upgrade to 2017/18 earnings estimates.

Citi prefers the former for its copper leverage, thanks to the Carrapateena development in South Australia. Oz Minerals compares well to global producers and ranks fourth out of the 16 stocks in the broker's global review, on metrics such as C1 costs and earnings per share growth.

Sandfire is a high-quality operator with more leverage to copper prices but the broker remains troubled by the diminished mine life at DeGrussa, which requires exploration success.

Inflation Risk Indicator

ANZ Bank researchers have developed a measure of future inflation probabilities for Australia, called the ANZ Inflation Risk Indicator. This measures the probability that underlying inflation over the next 12 months will fall within one of three compartments: less than 2%; between 2-3% (the central bank's inflation target band); and above 3%.

Assessing the likely future path of inflation is useful in determining the implied policy bias and likely action from the Reserve Bank of Australia. The analysts are encouraged that the indicator shows inflationary pressures in Australia are weak but also stabilising.

Returning inflation to the RBA's policy target band is likely to occur only gradually according to the indicator and this supports the analyst view that monetary policy is on hold for this foreseeable future and the cash rate is likely to remain steady at 1.5%.

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