The Wrap: Insurers, Telcos And Consumers

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Weekly Broker Wrap: insurers; banks; telcos; and consumers.

-New operators taking market share in general insurance
-Macquarie suggests challenging operating conditions captured in bank valuations
-Merged TPG/Vodafone likely to raise competitive stakes in mobile
-Consumers using savings to support retail activity

By Eva Brocklehurst

Insurers

Challenger brands are not the only ones taking market share in insurance. Automotive clubs such as RACQ & RAC, and international operators that are expanding risk appetite, such as AIG and Zurich, are taking share of personal motor and home products at the expense of Suncorp ((SUN)) and Insurance Australia Group ((IAG)).

Youi has revealed a 24-month trend of slowing customer acquisition and is not the face of competitive tension in Australia any more, Macquarie suggests. Smaller insurers that have the technology and products are outperforming.

The broker suspects lost volumes for IAG and Suncorp could place additional pressure on their gross expense ratios. Macquarie considers the sector is overvalued at current levels and maintains Underperform ratings on both stocks.

For the second consecutive year, Youi Australia experienced relatively stagnant gross written premium growth versus the mid-single digit growth seen in domestic general insurers. While Youi's profit margins are expanding, UBS notes this is at the expense of top line growth.

The company's strategy appears focused around gradual expansion into CTP and commercial lines rather than aggressive action on personal lines. The broker believes margin expansion in commercial lines will become increasingly important into FY20.

While there may be risks from the Royal Commission, Citi suggests general insurance remains the most attractive part of the sector. The broker believes QBE Insurance ((QBE)) currently offers the best value and, while the risk profile is elevated, further progress is likely, and there is meaningful upside if forecasts are delivered. Citi retains a Buy rating for QBE and Neutral for the others in the sector.

Achieving a 10% return-on-equity target is now in sharp focus for Suncorp in FY19 but costs need to be removed, Citi suggests. The sale of the life company should mean capital is returned but the broker considers the value of the business is now less attractive. The valuation of IAG is also a stumbling block for Citi.

Banks

Macquarie believes the challenging operating environment for banks is captured in current valuations. Compliance related expenses are likely to continue increasing as banks respond to the Royal Commission recommendations. Regulators appear largely done with implementing changes relating to housing underwriting, and the broker notes borrowing capacity has reduced by -15-25% since 2015.

Regulators also recognise the need for more uniform regulation. Macquarie suggests potential changes to negative gearing could have a significant impact on property prices and borrowing capacity as lenders remove negative gearing benefits from calculations. Remediation and system changes are also likely to be costly and reduce, in the short term, a bank's ability to benefit from automation.

National Australia Bank ((NAB)) has broken ranks, announcing it will leave its standard variable mortgage rate unchanged at 5.24%. Morgan Stanley believes this decision indicates that the scrutiny on conduct and competition is affecting management's decision making and this will weigh on profitability and the share price.

The bank has not ruled out future re-pricing and will continue to regularly review its rates. Morgan Stanley also doubts the bank's lower rate will drive material increase in new loans, given the amount of front-book discounting, although it may reduce the risk of switching by existing customers.

Telcos

UBS assesses that Telstra ((TLS)) desires to maximise returns on invested capital within a framework that targets an “A” band credit rating, while Optus is focused on free cash flow and has consistently streamed $550-600m in dividends per annum to Singapore Telecom. Meanwhile, TPG Telecom ((TPM)) is indirectly servicing $4.8bn in debt in regards to the Vodafone Australia merger plan.

Based on the above and recent price signals, UBS asserts that, while Telstra would prefer a benign mobile environment, Optus and TPG believe share gains are enough to offset re-pricing and are likely to compete aggressively. The broker believes their success will hinge on how aggressively Telstra defends its share.

The broker's base case assumes the merged TPG/Vodafone competes aggressively, but intelligently, in enterprise, where Vodafone has a smaller mobile back book, and via a differentiated TPG mobile brand in the consumer segment.

The broker assumes the Optus share declines only slightly, as the pressure from TPG/Vodafone in the metro area is offset by regional gains from recent network investments. Telstra's share is expected to fall -400 basis points because of competition and other structural drivers.

Australian Consumers

Financial conditions remain difficult for consumers, although retail spending improved in 2017-18 as savings were used to support activity. However, Deloitte Access Economics, in its latest retail forecasts, points out this situation cannot last forever. A further pick-up in retail expenditure is dependent on stronger wage growth and this may take time to eventuate.

While the good news is that retailers are still experiencing sales growth, the household savings ratio fell to a decade low of 2.1% in March this year, less than half the 4.7% of March 2017. Retail quarterly turnover at the end of June increased 1.2%, the strongest rise of the financial year. The analysts believe the trend is unlikely to continue in the second half of 2018 as household budgets are coming under pressure from weaker house prices, rising non discretionary costs and soft wages growth.

Moreover, non-food prices declined for the fourth consecutive year, although the rate of decline may decelerate as household incomes rise and the impact of structural changes in the market start to dissipate. Deloitte Access Economics suggests weaker confidence will reduce spending on large items and as wages slowly pick up this would provide a broad boost to food, apparel and other staples.

While intense competition and rising operating costs will weigh on many retailers, the analysis suggests those focused on value are likely to do well. Discount department stores are being supported while closures across apparel suggests many in that segment continue to struggle.

Apparel retailing, after growth impressed in 2018, is likely to moderate significantly in coming years, the report suggests. This is because of the introduction of "fast fashion", overseas fashion houses and online stores. The analysts suggest it is unlikely that growth in recent years will be repeated without another large industry transformation.

Meanwhile, household goods retailing is influenced by the state of the property market and the recent decline in house prices, particularly in Victoria and NSW, is expected to apply pressure on demand for household goods. Catered food sales are expected to lift growth levels over the short term before moderating.

Online retail sales continue to occupy a portion of consumer spending and represents just under 9% of total retail sales. The largest categories are homewares, media and groceries. Although online continues to outperform, growth has slowed to 17.7% in the year to June, down from 18.1% a month prior.

Growth in online department stores has expanded rapidly but only accounts for a modest share of spending and the three largest states account for almost 78% of total online spending over the past three years.

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