Weekly Reports | Nov 25 2016
Commodities and economic outlook; outlook for equities; OPEC production meeting; outlook for airlines; and Netcomm's NBN contract.
-Commodity boost to budget expected to be undermined by low wages growth
-Oz equities still considered reasonably attractive versus very low interest rates
-OPEC deal should be forthcoming, with surplus scenario likely if it fails
-Noticeable improvement in domestic airline passenger growth and yields
By Eva Brocklehurst
Commodities And Economic Outlook
A surge in the price of a number of Australia's key commodity exports since mid year has been widely flagged to provide a boost to the nation's economy. This includes the additional revenue to the federal government coming from increased tax receipts. The spot prices of three key commodity exports, iron ore, coking coal and thermal coal have risen sharply this year and, more generally, Commonwealth Bank analysts note, the Reserve Bank's non-rural commodity price index is up 17% since June.
Nevertheless, weak wages are expected to be a drag on budget revenues. Annualised wage growth for the September quarter was 1.6%, well below the 2016 budget assumptions of 2.5%. The analysts suspect this will reduce revenues and may offset the gains from higher commodity prices.
The CBA analysts suspect the size and relative strength of the NSW and Victorian economies means economic data presented at the national level is masking weakness throughout the rest of the country. Economic activity in the two biggest states, along with strong dwelling price growth in Sydney and Melbourne, is likely to mean the Reserve Bank prefers to stay on the sidelines in terms of its cash rate. This is despite the fact the rest of Australia could probably do with more easing of interest rate policy.
The analysts note that, during the mining investment boom, Australia was referred to as a "two-speed" economy, where relatively high interest rates and a strong Australian dollar weighed heavily on the rest of the country, while Western Australia, Queensland and Northern Territory experienced full-blown growth. Now this “two-speed” feature applies again, but this time it is NSW and Victoria driving demand and employment growth.
UBS expects the headwinds which have buffeted the economic outlook in the past few years, such as falling commodity prices and the drag from falling capital expenditure after the resources boom, will ease. As such, Australia's growth is forecast to strengthen to 3.0% in 2017, before easing to 2.8% in 2018. Through 2018 UBS expects growth to retrace as the booming housing construction cycle goes into reverse and the initial boost from public sector expenditure fades.
Growth is forecast to slow to 2.5% by the end of 2018. Inflation is expected to remain subdued and only return to the Reserve Bank's 2-3% target in the first half of 2018. UBS expects the RBA to keep the cash rate on hold before starting to normalise rates with a 25 basis point hike late in 2018 to 1.75%.
UBS considers a large and/or rapid drop from current levels is a key risk to factor in for equities in the coming year. Australian valuations appear moderately expensive in absolute terms but the market is still reasonably attractive compared with what are very low interest rates.
Australian earnings looks set to move back to positive growth in FY17 after two years of negative growth but, ex resources, trends appear still quite constrained, UBS observes. The broker remains relatively neutral on the banks, which appear reasonable value while the issue of their capital ratios is pushed out beyond 2017. UBS remains overweight resources.
Deutsche Bank believes the current price/earnings (PE) settings are about right and envisages earnings taking the market 4% higher over the next year. On the equity side, yield stocks have moved in line with bond yields and no longer look rich, with the broker noting the excess dividend yield that yield stocks offer is now close to the six-year average.
The broker likes some yield exposure at these levels and key picks include Telstra ((TLS) and Sydney Airport ((SYD)). In terms of the value trade the broker favours low PE stocks and key picks are Macquarie Group ((MQG) and Suncorp ((SUN)). Deutsche Bank remains a little concerned about domestic growth and expects reductions in official interest rates in 2017.
Australian dollar weakness and the prospect of better US growth leads the broker to include US exposure and key picks include Aristocrat Leisure ((ALL)), Amcor ((AMC)) and Incitec Pivot ((IPL)). In housing the broker sticks with a positive view and key picks include Fletcher Building ((FBU)) and Harvey Norman ((HVN)).
Macquarie believes agreement on production reductions by OPEC (Organisation of Petroleum Exporting Countries) has a 60% chance of success when the cartel meets on November 30, with a low US$50 price range for oil in the event of success and low US$30 on a failure to make a deal. Most OPEC members are at, or near, their production plateau levels, which the broker observes has not been the case since 2014, and should make a deal more palatable.
The form of a potential deal is far from settled. If OPEC fails to agree, Macquarie expects it will lose the power to jawbone the market and be on its way to dissolving, while members would be locked into a crude production race. Failure would force members to maximise production, resulting in large increases from Saudi Arabia, Iraq, UAE, and, eventually, Kuwait.
In this scenario the broker believes OPEC could quickly arrive at 34.5m barrels per day and create an oversupply for 2017 and part of 2018. In Macquarie's view, lower non-OPEC production would not be enough to offset OPEC growth as a result of the failure to obtain an agreement.
Ord Minnett observes a noticeable improvement in domestic passenger growth and yields in September, and what appears to be a more disciplined approach to international airfares to and from Australia by competing carriers. These developments have positive implications for Qantas ((QAN)) and Virgin Australia ((VAH)).
The number of passengers flying domestically grew 3% in September versus the previous September, and represent an improvement on the 2% growth in August and 1% growth in July. This confirms the broker's view that the July-August period was hurt by events such as the federal election.
The broker estimates yields in September in some key routes rose by 3-18% but, while these numbers are encouraging, cautions that average yields across the first quarter of FY17 were still down by 2-13%. In international routes passenger numbers grew by 6% in August, while average yields across the September quarter ranged from down 20% to up 10%.
Netcomm Wireless ((NTC)) has announced a contract with the National Broadband Network (NBN) for the roll out of its fibre technology (FTTdp or fibre-to-the-distribution point). This technology strikes a balance between the higher speed, but more expensive, FTTP (fibre-to-the-premises) and a technically inferior, but cheaper, FTTN (fibre-to-the-node).
FTTdp uses more fibre than FTTN as it extends to the kerb outside a property. The company's contract is for roll-out likely starting in FY18, which means production needs to start several months in advance.
This is a significant contract for earnings and, accordingly, Canaccord Genuity increases EBITDA (earnings before interest, tax, depreciation and amortisation) estimates by 27% for FY18, while FY19 is increased by 21%. Importantly, in the broker's view, the company is now well placed to win future similar contracts overseas.
Arguably, FTTdp is a bigger opportunity than fixed wireless because it addresses the issues in metro areas, where the majority of the company's target market resides. Canaccord Genuity increases its target to $3.50 from $3.20 and retains a Buy rating on the stock.
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