The Wrap: Utilities, Retailing & Supermarkets

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Weekly Broker Wrap: utilities; automotive retailers; building materials; housing-related retailing; and supermarkets.

-Risks emerging for traditional energy supplier profits
-Rebound in house prices could signal a recovery in car sales
-US-exposed building material stocks have more favourable outlook
-Improving outlook for retail sales as FY20 gets underway
-Promotional intensity, deflation easing for the supermarkets sector
 

By Eva Brocklehurst

Utilities

Utilities are changing. Morgan Stanley has conducted a survey that reveals disruption to the conventional utility-consumer model is looming sooner than many expect. One in three consumers is planning to generate their own electricity in the next five years and most expect to trade excess energy in future.

The broker assesses this trend will accelerate once energy technology is installed, as it increases the likelihood consumers will want additional technology. Young consumers show higher awareness and interest in the prospect and, as time passes, costs will come down even further.

Morgan Stanley believes this means risks for traditional energy supply profits will emerge more strongly. The broker has a Cautious industry view on Australian utilities, supported by the probability that incumbents with vertical integration will face structural challenges.

AGL Energy ((AGL)) and Origin Energy ((ORG)) can benefit from higher prices but, absent any counter measures, the broker suspects they are likely to sell less to fewer customers out of growing cost bases as ageing plants require replacement.

Automotive Retailers

Total sales for motor vehicles fell -9% in the June quarter and UBS expects sales to remain in negative territory until the June 2020 quarter. Prestige/luxury car sales are likely to return to growth earlier, forecast to lift 4% in 2020, after suffering more severe declines over the past 16 months.

As Australian house prices are likely to be nearing a nadir, the broker calculates that a 10% rebound in house prices could mean total new car sales rise by 8% over two years. While ride sharing and robo-taxis (autonomous vehicles) would mean lower new car sales in the future, UBS believes volumes are still likely still grow globally until at least 2030.

The broker considers the improved outlook is positive for Automotive Holdings ((AHG)). That company's merger with AP Eagers ((APE)) is pending an ACCC decision on July 26. The preliminary view asserted the proposed merger was unlikely to substantially lessen competition, although the effects on the Newcastle/Hunter Valley region were still being assessed. As an option, AP Eagers has proposed the divestment of its Kloster Motor Group business.

Building Materials

JPMorgan notes housing starts have fallen short of expectations in 2018 in both Australia and the US. Housing starts fell -26% in the March quarter and approval volumes are firmly in decline, while leading indicators are weak. JPMorgan expects housing starts to fall -18% in 2019 and a further -3% in 2020 before recovering in 2021.

This is expected to provide a tough backdrop for Adelaide Brighton ((ABC)) and CSR ((CSR)), which are exposed 55% and 32%, respectively, to residential construction activity. The broker envisages significant support for both James Hardie ((JHX)) and Reliance Worldwide ((RWC)), expecting earnings growth will materialise in coming years.

This stems from leading indicators in the US, which signal mortgage rates and application volumes are improving and comparables becoming easier. The broker is also overweight on Boral ((BLD)), believing the implied valuation for North America is too low.

Housing-Related Retailing

Housing finance declined -16% in May, a weakening of the three-month trend, Citi observes. The broker believes churn, including refinancing, is an important indicator of expenditure in housing-related retail categories and this points to weak sales persisting into the first three months of FY20. Until there is a significant pick-up in the volume of home purchases, retail expenditure is expected to remain soft.

Still, the broker takes a positive stance on household incomes in FY20, believing the benefit from the Commonwealth government's tax offset is likely to be most evident in August through to October. The broker expects the tax offset to buttress sales for retailers of food, apparel and smaller electronics.

Furniture, hardware and white goods are more likely to wait until 2020 for sales to improve. The broker retains Buy ratings on Super Retail ((SUL)) and Flight Centre ((FLT)) and remains more cautious about JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)).

Supermarkets

The latest survey from UBS found loyalty has overtaken price as a driver of expenditure for supermarkets. Momentum is building at Woolworths ((WOW)) while Coles ((COL)) has stabilised it share overall. Meanwhile, Aldi's share is growing at the expense of the Metcash's ((MTS)) IGA group.

What surprised the broker was the revelation that consumers were experiencing promotional fatigue and demanding more differentiated offers. The broker queries whether Metcash is being rewarded for investing in promotions, given its share was down because of perceived poor pricing.

The broker is watching the performance of Aldi carefully as new formats appear to be resonating with customers. Overall, UBS believes the results were positive for Woolworths and, while the read-through for Metcash was negative, this is currently priced into the stock.

The broker has evidence that deflationary pressures have eased in the June quarter, which is a positive for the supermarket sector. A study of weekly prices found deflation was -0.4% for Woolworths versus -0.9% in the March quarter. The broker suspects that, adjusting for a more material reduction in promotional breadth, Woolworths may have actually experienced inflation in the June quarter.

The broker was most surprised by the size of the fall in promotional intensity, particularly at Woolworths, which is consistent with the company's comments that promotional intensity is down around -17% for the past two years. Signs of dry goods inflation are also considered positive.

UBS forecasts food and liquor industry growth to accelerate to 4% over 2019/20 from the 3% recorded in FY18. This is driven by more rational pricing, slowing share gains for Aldi and supplier expectations for inflation across both fresh and dry goods.

UBS also believes Coles needs to lift its capital expenditure materially, while Metcash has an opportunity to spend more to lift wholesale sales. The broker is upbeat about the market becoming more rational and deflation trends easing, but suspects upside is being priced in from the improving backdrop and valuations are becoming full.

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