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The Wrap: Economy, Utilities & Building

Weekly Reports | Sep 13 2019

Weekly Broker Wrap: economic outlook; online classifieds; integrated utilities and building materials.

-RBA cash rate forecast to descend to 0.5% by February 2020
-Online property listings improve although growth absent
-Lower pool prices suggest risk to the downside for power retailers
-Decline in vacant land sales signals downside risk for housing approvals


By Eva Brocklehurst

Economic Outlook

National Australia Bank economists now factor in an additional reduction in the Reserve Bank of Australia's cash rate in February 2020, to take the cash rate to 0.5%, at which point the RBA is likely to signal intentions regarding unconventional monetary policy.

The next reduction of -25 basis points is still expected in November 2019, taking the cash rate to 0.75%, but the possibility of a reduction as soon as October cannot be ruled out if there is further weakness in the labour market.

Westpac economists expect that by the time of the October meeting, the US Federal Reserve will have reduced the federal funds rate further and, in turn, this will restrict the impact on the Australian dollar of recent rate reductions by the RBA. This state of affairs will then signal a need for further action.

A reduction in official cash rates in October of -25 basis points, from the current 1.0%, also leaves the RBA the option of a further reduction in December should conditions worsen, particularly in the global environment. Westpac economists also expect another -25 basis points cut in February 2020.

Unless the federal government delivers a meaningful fiscal stimulus, a further reduction to 0.25% for the cash rate is then forecast by NAB economists for mid 2020. To date, the government has focused on the objective of returning the budget to surplus. NAB economists continue to envisage a need for additional fiscal stimulus through new infrastructure investment, cash hand-outs and/or the pulling forward of tax cuts.

Their forecasts reflect downside risks to the domestic economy and greater uncertainty regarding the world economy. Growth continues to undershoot forecasts and inflation remains stuck below the RBA's 2-3% target band.

Public spending is strong but private demand has fallen for the first time since the global financial crisis. The NAB August business survey revealed no easing of the downward momentum in private demand and internal data indicates rate cuts and tax refunds have done little to boost consumer spending in July and August.

House prices may have picked up in a number of cities, which could limit further wealth affects, although leading indicators suggest the sharp downturn in residential construction could deepen.

The business survey indicates there has been little contribution to growth from the business sector outside of mining. Business confidence in conditions remain weak and well below long run averages, although still positive. Indicators suggest a turnaround in conditions is not imminent, as forward orders are negative and capacity utilisation well below levels seen 12 months ago.

Despite the gloom, NAB forecasts are for GDP growth of around 1.7% in 2019 and 2.25% in 2020. The unemployment rate is expected to rise slightly, reaching 5.5% late in 2020. The economists point out RBA growth forecasts remain at least 0.5 percentage points stronger than their projections.

Westpac economists agree the real economy has deteriorated and the details in the latest GDP report are disturbing. Output grew by just 0.5% in Australia in the June quarter while annual growth slowed to 1.4%, the softest pace since the GFC. Westpac forecasts for annual GDP growth are 2.3% in December 2019 and 2.4% in December 2020.

Global indicators of growth, trade and manufacturing are all showing signs of slowing, beginning to have a more material impact on confidence and labour market conditions in the US.

Hence, the Westpac economists now expect the US Fed to fulfill expectations of an easing over the remainder of 2019 and make two additional reductions in 2020, taking the federal funds rate to 0.875% by mid year. Other central banks are also poised to add stimulus.

Online Classifieds

Online property listings continue to improve although there is no growth versus the same period in 2018. For the four weeks to September 8, capital city new listings were down -15.7%. UBS also notes the decline in total listings is accelerating, a function of growing buyer demand and a relatively low listing of new stock.

The broker expects REA Group ((REA)) and Domain Holdings ((DHG)) are already factoring in a gradual improvement in new listings, anticipating a return to growth in the second half of FY20.

Integrated Utilities

Pool prices are the largest single driver of electricity market earnings, Morgan Stanley points out, while retail transfers have, historically, been only a minor input. Churn away from incumbents is down -23% in the year to date to absolute levels not seen since 2003.

Meanwhile, the closure of the Hazelwood power station led to a price increase, but backwardation of the forward curve – where the spot price is higher than the forward price — has not eventuated to date. Delays in commissioning, rising fuel costs and increased intermittency from both thermal producers and renewable entrants played their varying parts.

The broker's latest analysis of "daylight" discounts shows that these prices are -10% lower than in the previous autumn-winter period. Therefore, the backwardated forward curve continues to be used in Morgan Stanley's estimates.

Pool price reductions of -$5-20/megawatt-hour across the states in the national electricity market are forecast. This would create operating earnings (EBITDA) headwinds in the order of -14% for AGL Energy ((AGL)) and -7% for Origin Energy ((ORG)). The risk is skewed to the downside as lower pool prices persist, the broker adds.

Building Materials

Vacant land sales in the main growth corridors have continued to decline, now near a 10-year low, UBS notes. Moreover, land sales appear to lead detached housing approvals by nine months. Hence, this signals downside risk for detached housing approvals towards a trough of 80-90,000 in early 2020. UBS suggests this could partly explain the dip in approvals in July and the August numbers will be scrutinised.

One potential factor that may offset this trend is excess land inventory. The broker assesses building material suppliers such as Adelaide Brighton ((ABC)), Boral ((BLD)) and CSR ((CSR))  carry increased earnings risk if housing approvals trough or are sustained below 170,000, as competition would rise and margins come under pressure.

However, UBS remains constructive, expecting the trend to improve in 2020 as house prices and clearance rates are rising. The broker remains wary of Adelaide Brighton's 2019 guidance, as it implies no further deterioration in the second half. For those with Australian exposure UBS prefers Boral.

If earnings risks lift for locals, the broker expects interest will move towards those stocks with more US exposure. In this case James Hardie ((JHX)) is preferred, as it is taking market share, while Reliance Worldwide ((RWC)) faces Brexit uncertainty.

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