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The Wrap: Turkey, Drought & Big-Ticket Retail

Weekly Reports | Aug 17 2018

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Weekly Broker Wrap: Turkey; drought; slot manufacturers; pathology; renovations; and big-ticket retail.

-Turkey crisis: global re-pricing could impact on Australia's credit market
-Scrap steel prices the victim of turmoil in Turkey
-Drought could reduce Australia's GDP by -0.5% in FY19
-Recent contraction in pathology centre numbers
-Home loans falling and first indications of weakening in renovations
-Signs housing slowdown is affecting big-ticket retail items

 

By Eva Brocklehurst

Turkey

The sharp depreciation in the Turkish lira has raised concerns regarding a contagion effect. Nevertheless, ANZ analysts suggests direct exposure to Turkey is small in the Asian region. Spanish banks have the largest exposure, followed by French banks.

South Korean and Taiwanese banks represent less than 1% of total foreign bank claims. Asian currencies have depreciated since mid June but this is because of escalating trade tensions between the US and China.

This trend stabilised just as the Turkish lira plunged. Still, the analysts note there has not been a material rise in sovereign CDS (credit default swap) spreads in Asia and Turkey's troubles are unlikely to impact the region.

UBS suggests some vulnerabilities do exist in South Asia, although the region is in better shape versus five years ago. The exceptions are the Philippines, which moved into current account deficit in the first half, while Malaysia's reserve position appears low on the IMF's measure, although higher oil prices and a positive current account balance help.

UBS suggests the greater risk is for a broad "risk-off" environment where valuations could fall before finding a floor. This could end up being excessive, given the fundamentals, but remains a greater risk than a run on liquidity or a sharp ratcheting up of the risk premium.

The European central bank has flagged risks to the banking system from problems in Turkey yet still intends to exit its quantitative easing policy. Credit Suisse considers a re-pricing of risk is likely in this environment.

Turkey has foreign currency denominated debt equivalent to 40% of GDP. Leverage and thin capitalisation could amplify the shock coming through to Europe. Meanwhile, financial conditions in Europe have been tightening and are contributing to a slowdown.

The broker suggests global re-pricing is likely to have an impact on Australia's credit market, causing a tightening of financial conditions. This environment favours curve flattening, with some risks to currency. Within the equity market it underscores high-quality industrials over banks and resources.

Contagion aside, Macquarie analyses Turkey in terms of commodities. The broker finds it quite irrelevant for base metals, while a significant player in coal/energy markets and key in steel/steel scrap.

Turkey is that the crossroads of many global steel trade flows and was a small net exporter of steel in 2017. The unusual aspect is the country has an over-sized electronic arc furnace sector, accounting for 91% of steel production.

Scrap is relatively scarce domestically and the country is one of the world's largest buyers of ferrous scrap from the US, Europe and the former CIS countries. Scrap prices have been the victim of the turmoil in Turkey, as Macquarie notes prices dropped when a depreciating lira forced cash buyers out of the spot market. A weaker currency makes US dollar denominated scrap a lot more expensive for the Turkish steel mills.

The broker envisages -5-10% downside to scrap prices in the short term. With the US not being an option more Turkish steel may find its way to other markets such as the Middle East, where Turkey competes with southern European steel producers. Another option is Southeast Asia where the main competitor is China.

Drought

Citi observes recent work by the IMF has provided a new way to view the topic of climate change. The work identifies the impact sector by sector, with agricultural manufacturing historically affected by temperature.

The broker notes the average temperatures of the major eastern cities in Australia are between 15.1 Celsius and 21.5 Celsius, putting most of the country in a range in which rising temperatures are damaging.

Previous severe droughts reduced farm GDP by around -20% and even though the sector is only 3% of GDP this could still reduce economic growth by -0.5% in FY19. The broker suggests this is not factored into current economic forecasts.

Citi does not envisage any implications for Australia's Triple-A sovereign rating from the fiscal cost of supporting farms or the need for a temporary budget levy. Moreover, drought may lead to price spikes in the CPI but these are considered temporary.

Citi notes Nufarm ((NUF)), Inghams ((ING)) and Treasury Wine ((TWE)) are directly affected through reduced crops and yield and consequent rises in grain costs. A long run trend towards increased risk of drought presents more earnings volatility for Inghams and possible headwinds, structurally, for Nufarm.

Woolworths ((WOW), Wesfarmers ((WES)) and Metcash ((MTS)) are considered broadly exposed because of the inflationary impact of droughts on the food and beverage basket.

Slot Manufacturers

Macquarie has reviewed the performance of slot machine games within Australia during June. Aristocrat Leisure ((ALL)) is significantly outperforming peers and its new "Mighty Coins" series is performing well at 1.8x floor average. There has been no change in the performance of "Dragon Link ".

Ainsworth Game Technology ((AGI)) stabilised its game performance in June but still retains the lowest floor average versus major peers at 0.8x. Macquarie considers the Australasian Gaming Expo during August 14-16 will be an opportunity for Ainsworth to showcase its upcoming releases and any new configurations.

Pathology

UBS reviews pathology collection centre data which shows a recent decline in centre numbers for both Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)). A shift in momentum comes after a five-year period where Sonic Healthcare increased its collection centre numbers by 54% and Primary Healthcare by 58%.

UBS considers this early evidence that both may be now committing to reducing their cost base, although it remains unclear whether this strategy will be maintained at a time when several smaller operators are looking to grow their referral base.

The broker suggests the trend may become evident with the FY18 results and/or FY19 guidance commentary.

Renovations

UBS believes its credit tightening thesis is playing out. The value of home loans in June was at its lowest monthly level since August 2016, falling by -8.4% and the largest fall since April 2016.

While the weakness is still driven by investors, owner occupiers are showing the first signs of weakness, now negative. While credit tightened and home prices started falling some time ago, the new development is weakness in renovations.

UBS suggests activity in renovations is likely to ease as total home sales fell -8-10% to the lowest level in 20 years and owner occupier loans for alterations & additions slumped. The broker expects there is little chance of a rebound in home loans, and credit growth is expected to halve in coming years.

Big Ticket Retail

Morgan Stanley notes Australian retail sales was slightly stronger than generally expected over the last three data prints, and this has meant investors are looking at discretionary consumer sector is a potential source of laggard value.

Nevertheless, the broker urges caution because there are signs the housing slowdown is starting to affect bigger ticket retail categories. Vehicle sales declined by -7.8% in July, the sharpest fall outside of the 2008 GFC.

Furniture sales also turned negative in July and hardware sales appear to have plateaued. The broker wonders whether efforts to attract consumers through discounts and promotional activity may now be going unheeded.

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