Weekly Reports | Nov 30 2018
Weekly Broker Wrap: housing; consumer; utilities; and regional banks.
-Evidence more people considering house purchases as affordability improves
-Yet, falling house prices could drag on consumption
-Pressures on households signal retailing becoming more challenging
-Winners from ALP policy likely to be network services, industrial consumers and existing renewable power plants
-Bell Potter suggests time is ripe for a Suncorp bank /Bendigo & Adelaide merger
By Eva Brocklehurst
ANZ economists find no evidence the pace of decline in Sydney and Melbourne house prices is easing. Nevertheless, the current environment is not all bad and risks are not all on the downside. A characteristic of the downturn is that it is unusually led by prudential tightening. It is difficult to ascertain just how long banks will continue to implement further credit tightening, or if more will flow from the final report from the Hayne Royal Commission.
Moreover, the federal election next year could mean a change of government, with adjustments to negative gearing and capital gains tax. The risks on the upside include the possibility that a competitive response across lenders limits tightening of credit or even unwinds some recent changes.
Improved affordability could also push buyers back into the market. Lower house prices are positive from an affordability point of view and the economists find evidence that people are considering now is a good time to buy.
Moreover, the economists assess dwelling price adjustment is coinciding with falling unemployment and rising household income. The housing market is not expected to stabilise until early in 2020 and the economists believe it will be difficult for the Reserve Bank to tighten monetary policy until some time after that.
UBS believes falling house prices are likely to drag on consumption, albeit with a lag of more than six months. The broker does not believe a recovery in income will be enough to offset the fading household wealth affect.
The broker's analysis finds new evidence of a strong wealth affect for richer and older households, with the drop in the savings rate to a post-GFC low driven by the richest 40% of households and older households aged over 55. This indicates a -10% fall in home prices alone could reduce nominal consumption by -2% in coming years.
UBS observes retailers are becoming more cautious and while this is yet to show up in official statistics, Christmas is likely to be challenging. The slowdown is stemming from pressures on household cash flow, softer housing and a tightening of credit.
If consumers become more cautious and save, retail spending will slow. A return to the 10-year average savings rate would drive more than -10% reductions to the broker's FY21 estimates for discretionary retail earnings (EBIT).
The grocery market appears more positive because it is now more rational. UBS reduces FY19-21 discretionary estimates by -3-4% and lifts supermarket estimates by 1-2%. The broker upgrades Woolworths ((WOW)) to Buy as the outlook for supermarkets is improving.
Negative aspects for discretionary earnings appear priced in and Premier Investments ((PMV)), Super Retail ((SUL)) and Bapcor ((BAP)) are all upgraded to Buy. Breville ((BRG)) and Myer ((MYR)) go the other way and are downgraded to Sell because of housing exposure risk for the former and high levels of operating leverage for the latter.
In view of the Australian Labor Party's proposed energy policy, should it win government in 2019, Ord Minnett believes the focus is on the right aspects of transition, including an increase in renewable power generation, an acceleration of residential and utility-scale storage, further augmentation of the power grid and improvements in energy use.
The targets appear ambitious, nonetheless, and the broker finds it difficult to envisage the goals being achieved. The winners are likely to be network service providers, industrial consumers and existing renewable power plants. Losers could be smaller retailers and gas producers.
Key tenets of the policy include the reintroduction of the National Energy Guarantee in its full form and the target of a -45% reduction in economy-wide emissions by 2030 from 2005 levels.
The policy is also targeting 1m household battery installations by 2025 and, in order to facilitate the roll-out of batteries, a $2000 subsidy is proposed for up to 100,000 households with a total pre-tax income of $180,000. There will also be another $100m targeted at renters and low income households to access the benefit of renewables.
Policy proposes a modernisation of the transmission and distribution network through a $5bn fund. The ALP also proposes $10bn in funding over five years to support large-scale renewable generation and storage. A national interest test is also proposed for new gas projects.
Citi believes the new policy suite, while maintaining overall targets, may differ in implementation with a new direct investment program possibly taking the weight of emissions policy in the sector in the event the NEG does not gain Liberal support.
A shift to a direct investment mechanism raises questions for investment certainty but the broker acknowledges the impacts of the new program will not be fully understood until a new government has time to work through the details. Citi's analysts have dismissed the 50% renewable energy target as an investment risk for the present, because of existing state-based schemes. There was no detail on the policy for the larger economy.
The broker suggests investors should not be anticipating a carbon tax or full carbon price, while a wider emissions trading scheme will likely consider a set of trajectories which trend down over time, with companies only liable for their emissions above these trajectories.
It is also unlikely, in the broker's view, a default price in retail markets would affect earnings given the price of existing contracts relative to competitors. However, if prices for higher-priced contracts fell by -10% this could have a -5% earnings impact for both AGL Energy ((AGL)) and Origin Energy ((ORG)).
The lack of scale in regional banks makes it difficult to operate in a tough environment, Bell Potter observes. Yet creating of a meaningful challenger regional bank makes perfect commercial sense in the wake of the Hayne Royal Commission revelations about how little competition really exists.
The best combination, in the broker's view, is a merger of Bendigo & Adelaide ((BEN)) and Suncorp's ((SUN)) bank. Regionals have traditionally lagged major banks in productivity and efficiency and the cost benefits from such a merger would go a long way to mitigating this, in the broker's opinion.
The two banks are highly compatible in terms of culture, understanding of regional markets and familiar with multi-brand distribution. This would also provide scale for specialist segments such as agribusiness and small-medium enterprises as well as geographic diversity.
The broker would not anticipate any concerns from the Australian Competition and Consumer Commission in such a merger, given the current need for a trusted community-based challenger bank.
The broker's numbers suggests Suncorp could extract a premium of at least 20% for its bank and return surplus capital to shareholders based on a 50% share of synergies. The benefits to Bendigo & Adelaide shareholders would include material accretion, growth and valuation upside.
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