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The Wrap: Global Rates And Oz Building

Weekly Reports | Aug 11 2017

Weekly Broker Wrap: Global rate outlook; Australian building; motor vehicle replacement; Capilano Honey; Paragon Care.

-Western Asset suggests no imminent increase in global inflation or interest rates
-Accident replacement motor vehicles expected to double
-Key to growth for Capilano Honey is export markets
-Hard work by Paragon Care pays off in FY17

By Eva Brocklehurst

Global Rate Outlook

Western Asset, a global fixed income specialist, believes that despite subdued signals in many economies, global growth of around 3% is sustainable. The analysts believe that a slowing in overall growth will soon become apparent to the US Federal Reserve and may lead to the central bank being more cautious about rate hikes.

Western Asset continues to favour long US government bonds and is less keen on European, UK and Japanese government debt.  Nevertheless, the view suggests that there is no imminent increase in inflation or interest rates.

Western Asset downgrades the outlook for the US based on the recent absence of growth in capital spending, export activity and the related flattening out in the US factory sector. The eurozone is expected to grow at around 1.7-2.0% in 2017. With deflation risks dissipating, the analysts suggest the market focus has shifted to when the European Central Bank will normalise its monetary policy stance.

Western Asset believes the ECB will continue to maintain low interest rates, and asset purchases will continue into 2018. In Japan, growth is expected to improve to around 1.5% in the context of the current fiscal and monetary policies. The Bank of Japan is expected to continue with an accommodative monetary policy for some time in order to meet inflation goals. Western Asset still expects the yen to continue with its weakening trend against the US dollar.

Australian Building

Economic and industry researcher BIS Oxford Economics suggests Australia's building market will move into reverse over the next three years with a collapse in residential building commencements. In its Building in Australia 2017-2032 report, the researchers suggest the value of national building commencements peaked in 2015/16 at $107.3bn, up 22% in real terms since the end of the resources investment boom in 2012/13.

Over the next two years the fall in residential building commencements is expected to accelerate sharply, particularly in the investor-driven apartments segment, as supply catches up to demand. The total residential market is expected to fall by around -31% over the next three years but the decline in the number of private, high-density apartments being started nationally will be closer to -50%.

The slump is expected to be, in percentage terms, similar to the residential downturns in the mid 1990s and during the introduction of the GST in 2000/01. The analysis indicates that dwelling construction in all states, with the exception of Victoria and NSW, is either in balance or oversupply.

High-density dwellings take longer to complete than traditional detached housing but the researchers suggest that when the end of the boom comes it will be swift. A milder decline is forecast for detached houses.

In contrast, the value of non-residential building commencements is expected to rise in 2017/18. Improved economic conditions along the eastern seaboard are driving new commercial and industrial developments. Further afield, the total value of non-residential building commencements is expected to ease later in the decade, meeting the downturn in residential commencements.

Weaker prospects for growth in retail sales are expected to feed through to a narrow pipeline for retail projects, and a tripling of accommodation commencements since 2012/13 may also push activity in this segment to its peak, resulting in a correction.

In summary, with residential building activity now set for a sharp decline, along with the multiplier impact on industries such as construction, manufacturing and retailing, the researchers believe the Australian economy will need new drivers of investment to support growth and employment.

Accident Replacement

Under Australian common law a driver that is not at fault is entitled to a hire car paid for by the at-fault driver but this right is largely unrecognised, as only 18% of potential hires take up the offer. Nevertheless, Morgan Stanley observes take up has been growing in the last five years and calculates the potential number of hires based on the experience in the mature UK market, where 70% of drivers not at fault take up the offer.

The broker expects this market to more than double in Australia and determines the market opportunity using factors such as the penetration rate of potential hires, average length of repair and rental price per day and estimates a total addressable market of $703m in Australia.

EclipX ((ECX)) owns the Right2Drive business, a leading operator in the accident replacement vehicle market. The business may make up only 14% of the company's operating earnings in FY17 but is a meaningful driver of growth and is likely to contribute 3-5% to earnings growth over FY18-20 on Morgan Stanley's new forecasts.

For the insurers, Morgan Stanley calculates an increase in premiums by around 8% would cover the claims costs in a fully penetrated market. Insurers are expected to price to offset claims inflation and earnings estimates would only decline for the major insurers by -1-2% if price increases are not implemented.

Capilano Honey

Capilano Honey's ((CZZ)) FY17 results were subdued because of increased investment. Morgans expects the company to return to double-digit growth in FY18 but has lowered forecast to reflect the additional costs associated with the development of new product, such as Beeotic, and increased marketing activity.

Beekeeping operations were affected by unfavourable seasonal conditions, resulting in both joint ventures sporting small losses. The stock trades at a material discount to peers and the broker maintains an Add rating and $18.05 target.

Looking into FY18, Canaccord Genuity believes the key to growth will be export markets. Growth in the domestic market is expected to become harder, amid more competition from Beechworth. The broker believes the company's strong position in its category justifies a market multiple despite the lack of growth.

Should demonstrable growth materialise in export markets a re-rating to a growth market multiple could be justified. Hence the broker, not one of the eight monitored daily on the FNArena database, retains a Hold rating and a $16.38 target.

Paragon Care

Paragon Care ((PGC)) pleased Bell Potter with its second half result, confirming that earnings are now heavily skewed to the latter half of the year. The broker still finds estimating the organic growth in revenue problematic, as there have been numerous acquisitions recently, but its best estimate is around 6.5%.

The company has not provided specific earnings guidance for FY18 but the outlook remains supportive of growth. The broker notes strong growth in ophthalmic, aged care and service and maintenance businesses. Bell Potter, not one of the eight monitored daily on the database, maintains a Buy rating and $1.02 target.

The result beat Shaw and Partners' forecasts and is seen validating the hard work management has put into re-building the earnings profile. The broker believes this stock is a non-discretionary exposure to Australia's ageing population, with a footprint that enables bolt-on acquisitions to be grown quickly and relatively cheaply. Shaw and Partners, also not one of the eight monitored daily on the database, retains a Buy rating and $0.95 target.

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