Weekly Reports | Jun 07 2019
Weekly Broker Wrap: housing; banks; and online classifieds.
-Large obstacles to a turnaround in Australia's housing market
-With further official cuts on the cards, bank interest margins are under pressure
-UBS observes improved execution by online classifieds
By Eva Brocklehurst
Australia's housing market has been weak. Despite the easing of lending guidelines and official rate reductions by the Reserve Bank of Australia, difficulties continue. Baillieu analysts consider oversupply, record leverage and elevated valuations, as well as high investor exposure, are among the obstacles to a turnaround.
They assess that the -30-35 basis points coming off mortgage rates in the near term is a much smaller increment than the -200-385 basis points that have driven the last three recoveries in housing.
In the US, early indications suggest a recovery is underway as broad fundamentals are supportive. In contrast to Australia, there is a growing undersupply of housing, low leverage and reasonable valuations.
The analysts believe this skew to the US for housing growth supports companies such as James Hardie ((JHX)), Boral ((BLD)) and Reliance Worldwide ((RWC)), which have US exposures of 67%, 35% and 53% of sales, respectively. Moreover, all have been materially de-rated and are trading at the lower end of valuation ranges.
Morgan Stanley notes Australian house prices nationally fell -0.4% in May, to be down -10.1% from the peak in late 2017. Detached housing fell more than apartments over the month. While sentiment has improved materially in Australia over the past few weeks, with the return of the Coalition government signalling no change to negative gearing in the near term, fundamentals are still providing pressure.
Despite sharp falls in building approvals, housing supply is elevated and likely to remain ahead of new demand until late 2020, the broker believes. Economic growth is also likely to remain below trend for the rest of the year and the labour market is softening. This will put further pressure on incomes and offset some of the serviceability benefits of rate reductions.
A worsening outlook for the global economy also increases the downside risk. While there is likely to be less chance of a break through the floor of a -10-15% peak-to-trough decline in house prices, now the RBA is on the case, Morgan Stanley does not believe sentiment will allow prices to go materially higher.
UBS also expects a near-term bounce in the housing market following the election and rate reductions, but suspects the impact on credit growth will be muted and offset by mortgage holders increasing the paying down of principal.
As a further easing of the RBA's cash rates is on the cards, major bank interest margins are coming under pressure. UBS believes it is increasingly difficult for the banks to maintain their retail net interest margins in an ultra-low interest rate environment.
While the sharp compression of the BBSW-OIS (bank bill swap rate-overnight indexed swap) spread provides some near-term support for net interest margins, the global environment is challenging and Australian bond yields are at historical lows.
As bank hedges run off, the yield on the major banks' free floats will drop and UBS estimates this could reduce earnings by -6-8% over the next three years. In the event the RBA cuts the cash rate below 1% or initiates quantitative easing, the broker envisages further downside to earnings and dividends.
UBS expects regulators will pursue whatever it takes to avoid a hard landing in the economy but also wonders whether the “treatment is worse than the disease” if further stimulus is required.
Macquarie calculates that the -25 basis points reduction in the term structure of interest rates reduces major bank profitability by -2-3% and regional banks by -4-7%. However, the next forecast -25 basis points cut would have a cumulative negative impact on earnings of -5-7% for the majors and over -10% for the regionals.
The broker agrees falling interest rates are detrimental to profitability, predominantly because of margin squeeze related to deposit pricing elasticity. Bendigo and Adelaide Bank ((BEN)) is considered the most affected, given an overweight position in low-cost deposits and limited benefit from structural hedges.
Macquarie notes banks, historically, have been successful in re-pricing mortgage portfolios but this is likely to provide only short-term reprieve. While the outlook for banks is adversely affected by falling interest rates, the rationale for reductions to the cash rate reflects the challenges in the broader economy. In the longer term, the broker agrees, if rates continue to decline, banks are likely to deliver sub-optimal returns and trade at an elevated discount to the market.
Bell Potter believes recent changes at the board level for Suncorp ((SUN)), Bank Bendigo & Adelaide Bank and Bank of Queensland ((BOQ)) will lead to strategic reviews, and consolidation could go a long way to addressing some of the performance disparities.
A changing of the guard could also set aside some of the historical animosity over mergers. Bell Potter continues to envisage merits in a merger for Bendigo & Adelaide Bank and Suncorp Bank in terms of geographic diversity, regional market understanding and multi-brand distribution channels. In contrast, a merger between the two Queensland-based entities would concentrate risk.
The broker suspects the persistence of operating headwinds as well as recent changes at board level adds to the urgency for Suncorp to divest its bank and become a pure general insurer. Bell Potter remains comfortable with Hold ratings for Bendigo & Adelaide and Bank of Queensland, in anticipation of valuation upside from regional M&A activity. The broker retains a Buy rating for Suncorp.
UBS lifts long-term forecasts and price targets to factor in improved execution by REA Group ((REA)), Seek ((SEK)) and Carsales.com ((CAR)). Residential listings will remain the key value driver for REA Group and the broker expects Agent Edge will support longer-dated growth.
Meanwhile, for Seek the shift to a dynamic pricing model and the potential in the Chinese market are likely to underpin revenue. The opportunity in Carsales.com lies with lifting depth contributions closer to its peers and growing its international business.
While UBS lifts long-term forecasts and price targets to factor in improved execution, the market appears to be already pricing in success. Hence, Carsales.com is downgraded to Neutral from Buy while a Neutral rating is maintained for REA Group and a Sell rating for Seek on valuation.
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