The Wrap: EVs, US Construction And Oz Banks

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Weekly Broker Wrap: electric vehicles; US-exposed construction; infant formula; banks; and gaming.

-Stellar growth for electric vehicles in September
-Recovery in US housing affordability slower than in previous cycles
-Risks to the downside for Australian banks, housing downturn seen manageable
-Robust consumer is still noted at the gaming table
 

By Eva Brocklehurst

Electric Vehicles

Macquarie calculates almost 200,000 electric vehicles were sold in September, by far the highest on record. China remains the largest EV market, accounting for half of all electric vehicles sold. However the roll-out of Tesla's Model 3 continues in the US with sales up 109% in September, year-on-year. The US became the second largest regional market for EV sales, overtaking Europe.

The increase in EV sales was even more significant when considering that car sales of all engine types in countries covered by the broker's analysis were down -10% in September. The market share of electric vehicles in September in these markets was nearly 3.5% of all sales, with China on almost 4.5% and the US now approaching 3%. There is a clear upward trend in all markets, Macquarie observes.

The broker has long been optimistic about 2019, given the number of new models being launched by European and Korean firms, yet is currently forecasting a slowdown in global EV sales growth, to 35% from 64%.

The reason is that, in the US, the rapid rise of Tesla's Model 3 is now in the rearview mirror. Also, China's subsidy regime continues to be tightened. Still, the broker concedes 35% global growth is hardly slow.

For the battery metals – cobalt, lithium, nickel – expansion of EV sales is a positive demand story, particularly true, the broker observes, as average battery size continues to get larger.

US-exposed Construction Stocks

Residential construction data in the US has been soft recently and JPMorgan's analysts have downgraded projections for housing starts, to growth of 6% in 2018, 5.5% in 2019 and 4% in 2020.

Affordability pressures, rising new home inventory and an expected moderation in jobs growth can partly explain weakness in Boral ((BLD)), James Hardie ((JHX)) and Reliance Worldwide ((RWC)), they suggest.

While affordability is a clear constraint, JPMorgan asserts the balance of indicators is supportive of further growth and reaffirms an Overweight rating on all three stocks, believing the recent de-rating presents an attractive opportunity for investors.

UBS finds mixed signals from US housing activity. Growth in single-family permits appear on a trend decline and housing starts have fallen. The weakness can be attributed to reduced affordability and tight labour and land availability.

Yet demand should be strong, underpinned by rising wages, low unemployment and migration. The broker notes companies such as James Hardie and Boral continue to lift their selling prices to offset higher input costs.

The estimated cost to build a new home has increased by 6% since 2010 while US mortgage rates are lifting and growth in mortgages has started to slow. All up, UBS suspects a recovery in housing affordability is likely to be slower than in previous cycles.

In order to envisage a break to the trend, the broker would need to witness reduced supply constraints, either through higher wages, which lead to more building activity, or reduced expectations for rate increases.

Infant Formula

From UBS' analysis it appears like-for-like pricing in China's infant formula market remains weak, although, overall, pricing has been pushed into positive territory recently. Imported brands have reached 90% share of bestselling units, the highest percentage since 2016, albeit the price premium over domestic brands has fallen to its lowest point.

New e-commerce laws passed in September indicate the focus of regulation is shifting to cross-border e-commerce (B2C) rather than traditional channels. UBS perceives the changes are positive for compliant brands, although it might put pressure on some companies that rely on daigou or consumer to consumer (C2C) business, such as a2 Milk ((A2M)).

The broker finds the trends for a2 Milk encouraging, as market share and pricing are both improving. UBS suggests a recent sell-off in the stock is looking overdone and maintains a Neutral rating with an NZ$11.80 target.

Banks

Morgan Stanley retains a negative stance on Australia's major banks, as trading multiples do not yet provide sufficient valuation support to offset the structural and cyclical headwinds. The broker envisages downside to forecasts for earnings growth, profitability and dividends.

Factors weighing on the outlook could also take another 12-24 months to play out. Issues likely to drive share prices going forward include regulatory risk, end of the mortgage bull market, subdued business loan growth, elevated pay-out ratios & risk of dividend cuts, as well as innovation, disruption and the reinvestment burden.

In order to turn positive the broker would need to witness lower consensus earnings forecasts, a better outlook for the housing market and a stronger case for official rate increases.

Macquarie expects losses from across the housing portfolios of the banks will increase from current low levels but suggests they should remain manageable, even if house prices decline by an additional -15-20%. Given increased concerns around falling house prices and the litigation and remediation issues the broker has analysed the potential exposure of the banks to the risks.

With a subdued level of arrears in the mortgage portfolio Macquarie believes it would be difficult to show there was a direct link between a customers financial loss and the sector is responsible lending obligations, particularly if interest rates remain low. A potential exception is with respect to interest-only loans.

Westpac ((WBC)) is relatively more exposed than its peers to housing-related losses but the broker suggests the differences are not large enough to justify a material valuation discount. Macquarie continues to believe a -5-10% discount to fundamental valuations sufficiently captures the potential downside risk to the banks from future remediation-related expenses. The sector has circa a 7% dividend yield and the broker finds value at current levels.

Gaming Conference

Despite investor fears regarding rising interest rates and wages, gaming operators highlight a strong consumer at the G2E Conference. This was particularly for the unrated (no loyalty card) aspect, which is considered the best indicator of demand.

Fears rising wages will put pressure on margins were discounted, as management teams believe this can be managed, and rising wages indirectly translate into higher revenue. Moreover, in the face of rising interest rates management teams are intent on paying down debt and improving balance sheets.

Attitudes toward sports betting have also begun to improve, Macquarie notes. Suppliers are offering highly sophisticated retail betting products which should encourage more trips to the casino. In the case of slot games, sentiment towards new games was the best in years. Aristocrat Leisure ((ALL)) has been affirmed as a leader on the participation side, poised to continue gaining share, in Macquarie's opinion.

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