The Wrap: China, Industrials And Banks

This story features PENDAL GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: PDL

Weekly Broker Wrap: China's influence; fund managers; industrials; and banks.

-ANZ Bank economists suggest China's influence on Oz economy overstated
-Improvement in fund manager flows in September quarter
-Dry conditions favouring building stocks
-Tough reporting season ahead for the banks
 

By Eva Brocklehurst

China's Influence

ANZ Bank economists observe China's influence on Australia's economy has become somewhat mythical. Australia sends 30% of its exports to China, a higher share than any other country but this statistic does not provide any sense of how important exports are to different economies.

Scaling exports to China as a share of GDP ranks Australia third in terms of exposure, behind Korea and Saudi Arabia. Yet other factors are important. Not all countries benefit equally from currency depreciation.

In contrast to Australia, where the currency can depreciate sharply with few negative effects, emerging markets can often become destabilised because inflation expectations are not well anchored and domestic savings are less attached to the local currency.

The second factor, the economists point out, is the type of exports. Commodities make up 80% of Australia's exports to China while, for example, Japan and Germany primarily export manufactured goods.

A buyer of resources is unlikely to be concerned about whether goods such as iron ore come from Australia or Brazil and the price is the key to whether orders are reallocated. In contrast, a shift in geography for niche manufactured goods is likely to be more difficult.

In terms of the services industry, which includes Chinese tourists and education exports, the impact of any withdrawal is considered unlikely to greatly damage the Australian economy. In the case of tourists, Chinese expenditure represents only 0.6% of GDP while for overseas Chinese students, the aggregate GDP exposure is only about 1/10 that for traded goods.

Fund Managers

Fund manager flows in the September quarter showed signs of improvement as the rate of outflows slowed for Pendal Group ((PDL)) and inflows occurred for both Platinum Asset Management ((PTM)) and Magellan Financial ((MFG)).

Macquarie observes market performance made a positive contribution across the sector, with the exception of Platinum Asset, although trends in October could dilute these benefits to varying degrees.

Performance trends at Platinum Asset remain of concern for the broker and downside risk is envisaged for flows in coming months. Macquarie prefers Magellan Financial, noting a strong market performance over the quarter and improved retail flows.

It appears to the broker the de-rating on the sector has incorporated more downside and there is scope to re-rate in both absolute and relative terms. Macquarie upgrades its recommendation on Perpetual ((PPT)) to Neutral from Underperform, noting yield and valuation support is emerging despite further downside risk to flows for the near term. The broker also notes the rate of outflows has moderated for Pendal Group and the Australian business continues to impress.

Industrials

Morgan Stanley suggests unfavourable weather could affect a number of stocks across building materials and retail. Dry conditions carried into the second half of 2018 and, coupled with strong demand, provided a strong platform for trading in the September quarter.

A wet start to October across the east coast, with most pronounced impact in Sydney, suggests some reversal of favourable conditions should this continue. Boral ((BLD)) may have some downside risk for its Australian earnings if wet weather continues but its diversified geographic and product mix would mitigate this to some degree.

A wet start to October may mean CSR ((CSR)) issues more cautious guidance for the second half when it reports first half results in November. Morgan Stanley is also more cautious because of the stock's greater skew towards residential construction. Strong demand and more favourable weather would boost Adelaide Brighton ((ABC)) but, as the stock is trading at a premium to peers, Morgan Stanley retains an Underweight rating.

In retail, as Wesfarmers ((WES)) generates one third of its earnings from Bunnings, weather could cause consumers to delay or abandon home improvement projects and, combined with a slowing housing market, suggests slower sales growth in the first half. Meanwhile, a wet start to FY19 should support Domino's Pizza ((DMP)), the broker suggests, as, when it rains, consumers prefer to order in rather than eat out.

Banks

Current profitability for the banks has been driven lower, amid significant customer compensation and remediation provisions. Collectively, ANZ Bank ((ANZ)), Westpac ((WBC)) and National Australia Bank ((NAB)) have announced around $1bn, post tax, in provisions since the Royal Commission report was delivered in September.

Citi expects provisions will total around $2.1bn, leaving another $900m in compensation likely to be recognised in FY19. ANZ will report its FY18 result on October 31, National Australia on November 1, Macquarie Group ((MQG)) on November 2 and Westpac on November 5.

UBS agrees it is likely to be a tough reporting season for the banks given the political scrutiny and there is little likelihood earnings will surprise on the positive side. Costs remain elevated and revenue for the sector is expected to fall around -1.1%.

ANZ is continuing to grow owner occupier loans and shrink investor mortgages which, while prudent, is coming at the expense of volume and impacting on net interest margins.

National Australia Bank is the opposite, the broker notes, winning share in the small-medium enterprises markets as other banks tighten underwriting. Still, the bank's CET1 ratio is low and it may be forced to put a discount on the dividend reinvestment plan. The question UBS asks regarding Westpac is whether the bank can get costs down.

Ord Minnett expects a soft reporting season for the banks, hampered by customer remediation costs and interest margin pressure, with the strongest result coming from ANZ and Westpac likely to be the weakest.

Ord Minnett forecasts ANZ second half net profit of $3.05bn, down 13% half on half because of remediation costs. The broker expects ANZ to commit to further share buybacks in FY19 once the existing buyback is complete.

Westpac is expected to report a second-half cash net profit of $3.79bn, down -11% half on half. National Australia Bank is expected to hold its final dividend at $0.99 a share and initiate a -1.5% discount to the dividend reinvestment program.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms