The Wrap: Housing, Rates, Election & A-REITs

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Weekly Broker Wrap: house prices; RBA cash rate; Australian election; and A-REITs.

-House prices showing no signs as yet of a trough
-More than one cut to the cash rate could have major implications for banks
-ALP policy agenda likely to impact most sectors of the economy
-A-REITs reiterate guidance, office & industrial outlook the main positive
 

By Eva Brocklehurst

House Prices

Australian house prices fell again in April, to be -9.7% below the peak. Morgan Stanley points out forward indicators are not suggesting a trough has occurred, and expects prices to drop further.

National auction clearance rates have improved since late last year but remain at levels that imply more price declines. Broadly, national days on market and vendor discounting continue to deteriorate. A slowing residential construction outlook will also have an impact.

UBS agrees home prices show no signs of bottoming. House prices have slumped to their worst levels since the GFC and the broker points out the turnover rate has reached a record low of under 3%, which is a very negative indicator for renovations & consumption.

Going forward, UBS expects price reductions to reach -14% and create a negative wealth effect on consumption.

RBA Cash Rate

Morgan Stanley expects the Reserve Bank of Australia to cut official interest rates in November, acknowledging this is later than the market is factoring in. The market is implying a 50% likelihood of a reduction to the cash rate at the next RBA board meeting (May).

Morgan Stanley expects a reduction in the cash rate stemming from below-trend growth will only occur once the labour market shows sustained weakness. Moreover, while rate cuts may be helpful, the broker doubts these would result in a near-term trough in house prices.

Much of the credit tightness that has driven house price weakness has been unrelated to the price of credit and more linked to the regulatory environment. This is not expected to change.

JP Morgan concludes that the revenue impact from one cut to the cash rate would be manageable, with mortgage re-pricing modest, but two rate cuts may be more difficult for the banking sector to absorb, as concerns would be raised about reaching the lower bounds on some deposit costs.

Still, the broker expects this would help stabilise house prices and provide support for asset quality more generally. There is also scope envisaged for APRA (Australian Prudential Regulatory Authority) to relax its 7.25% interest rate floor, which is beginning to look implausibly high.

JP Morgan economists expect two cuts to the cash rate, in May and June. The broker acknowledges the market is a little less pessimistic, although is still pricing in at least one rate cut by the end of 2019.

The broker estimates that, for the major banks, 10-13% of funding sits in non-interest sensitive deposits and equity. Bendigo & Adelaide Bank ((BEN)) appears the most vulnerable of those under coverage, with its low-cost deposit/equity equivalent estimated at around 15% of funding and no replicating portfolio in place. Still, lower rates would make FY19 major bank dividend yields very attractive.

Australian Election

Implementation of an incoming federal government's plans after the federal election on May 18 is likely to be contingent on the cross-bench. Morgan Stanley's analysis indicates neither party appears likely to hold a majority in the Senate, although a hung parliament or minority government is considered unlikely.

If the Labor Party wins government, its reform agenda is likely to impact most sectors of the economy. Morgan Stanley believes it could obtain the bulk of its policy agenda and the degree of compromise would depend on the strength of its majority.

Both parties are focused on retaining a surplus and paying down debt. Moreover, a focus on budget discipline from both parties means any additional fiscal stimulus in the face of slowing growth is likely to be reactive. The broker considers current market pricing too optimistic, in that it implies a more favourable economic outlook and larger stimulus.

While the current government has longer-dated tax cuts the Labor Party plans smaller and more redistributive cuts. All up, the Labor Party's tax package will be modestly less stimulative to aggregate disposable income than that of the Coalition.

The Labor Party's intention to reduce the capital gains tax discount to 25%, and limit negative gearing to new properties, is expected to have a modest negative impact on house prices. The impact on housing turnover is likely to be comparatively larger. There appears to to be a relative subsidy for new construction but the ultimate impact, in Morgan Stanley's view, will depend on risk and return expectations.

The removal of imputation refunds is the largest near-term revenue raising activity in the Labor Party's policy. The greatest impact will be on high-yield stocks with a large domestic retail base, such as banks or telecommunications, while there may be some diversification into real estate investment trusts and other tax-exempt structures as they do not currently pay franked dividends.

Morgan Stanley considers the accelerated depreciation scheme in the Labor Party's policy, targeted at new investments to help boost business, will impact private businesses, which may be more cash flow constrained than larger companies.

Industrial relations proposals are not expected to have a near-term impact, although changes may raise labour costs for those stocks with a high degree of low-wage or flexible labour. Caps that the Labor Party is proposing to health insurance premiums, at 2% for two years, are expected to have negative earnings implications for both health insurers and hospitals.

A-REITs

A-REITs (Australian real estate investment trusts) underperformed the broader ASX 200 index in April. Citi highlights a resilient sector, as, on a market cap weighted average basis, growth is forecast around 2%. Charter Hall ((CHC)) is at the top end, with growth of 14-17% and Vicinity Centres ((VCX)) at the lower end, flat to down -1%. The office and industrial outlook is positive and Mirvac ((MGR)) is the pick for Citi in this segment.

There was no negative news flow in the latest quarter, and Shaw and Partners suspects the underperformance could simply have been profit taking after a good run. All A-REITs under Shaw and Partners' coverage reiterated full year guidance.

Residential-exposed A-REITs, Mirvac and Stockland ((SGP)), reiterated FY19 lot settlement targets but the broker downgrades Mirvac to Hold from Buy on the back of pricing movements, as it is trading well above target.

Citi notes Stockland's third quarter deposits were down -28%. Mirvac, more heavily affected by the timing of apartment settlements, also recorded materially lower numbers of settlements. Still, Citi believes Mirvac's large apartment settlement profile should bode well for FY20.

JP Morgan's preferred exposures are Vicinity Centres, Lendlease ((LLC)) and Charter Hall. The broker also downgrades Mirvac to Underweight, believing it to be fully valued. The broker envisages pressure on residential earnings beyond FY20, as sales rates have slowed noticeably.

Meanwhile retail sales trends were challenging, as expected. JP Morgan does not expect any material improvement in the retail segment in the June quarter, although fiscal and monetary stimulus could mean sales growth improves in the second half of 2019.

Citi also notes specialty sales growth decelerated in the March quarter and there is ongoing pressure on retail income growth. The environment is expected to get tougher with Vicinity Centres expecting no further disposals until after FY19. The broker reiterates its Sell call on Scentre Group ((SCG)), GPT Group ((GPT)), Charter Hall Retail ((CQR)), Shopping Centres Australasia ((SCP)) and BWP Trust ((BWP)).

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