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The Wrap: Dwellings, Currency & A-REITs

Weekly Reports | Oct 11 2019

Weekly Broker Wrap: dwelling starts; building materials; currency; grocery; and A-REITs.

-Latest dwelling starts imply downturn going forward
-JPMorgan suggests sales for CSR likely to slump
-Little support envisaged ahead for Australian dollar
-Foreign direct investment flows head back to Europe
-Deflationary pressures ease across the grocery market
-Pressure on A-REITs amid softening outlook for rental growth


By Eva Brocklehurst

Dwelling Starts

Second quarter dwelling commencements rose 1.1% but are still down -20.3% over the year. While private homes went backwards, down -16% year-on-year, the multi-unit and other dwelling category rebounded, albeit still down -26% year-on-year.

UBS notes, reflecting the prior boom, residential work under construction remains high but activity will fall sharply as annual completions drop to around 180,000 in 2020 from the current 217,000. This will also be a drag on consumption going forward.

Non-residential building commencements, meanwhile, were flat, down -18% year-on-year. The numbers imply a construction downturn going forward and UBS asserts, given sentiment has deteriorated, the Reserve Bank of Australia is likely to cut official rates by -25 basis points in November and again in the first half of 2020, taking the cash rate to 0.25%.

Building Materials

JPMorgan believes the latest building activity data, particularly residential commencements and completions, signals sales for CSR ((CSR)) will fall sharply in FY20. The broker forecasts CSR's building products revenue to decline -10%. Depressed spot aluminium prices will also impact on the profitability of the Tomago smelter, with JPMorgan noting the ingot premium for Japan has been trending lower.

The broker retains an Underweight rating on CSR and estimates for earnings per share in FY20 are -12% below consensus. JPMorgan expects dwelling commencements to continue moderating, presenting a tough back drop for Adelaide Brighton ((ABC)) as well.

Australian Dollar

UBS is bearish about the outlook for the Australian dollar, expecting it at US$0.66 by the end of 2019. Several factors are likely to apply the pressure, including lingering support for the US dollar. UBS doubts US dollar can weaken very much despite the fact US yields are fallen significantly.

Global growth is now in the 10th lowest percentile for the last 20 years and this backdrop tends to be supportive of the US dollar, not the least because US investors maintain a strong home bias in global downturns.

Weak global growth will also bring about risk aversion and the broker expects no significant de-escalation in the trade war. Moreover, UBS doubts lower interest rates will be bullish for equities over the more medium term, as eventually equities will have to adjust and catch up with weaker macro fundamentals.

As the RBA cuts rates further and the discussions centring on quantitative easing intensify, the broker expects the Australian dollar will retain a bearish tone. Finally, commodity prices are unlikely to offer much support for the currency. High iron ore prices are considered unsustainable and commodities are unlikely to cushion the impact of lower domestic rates and increased risk aversion.

Morgan Stanley points out the Australian dollar has not reacted to the drop in consumer sentiment, as indicated by the latest survey, implying markets are closely tuned to the US/China trade negotiations.

The broker suspects the US Federal Reserve has opened the way for balance sheets to expand and cope with the increasing liquidity being hoarded by the big banks. Importantly, net foreign direct investment has turned in Europe, flowing inwards as a weakening global investment climate makes corporates scale back from international activities. This recent shift in flows has not been reflected in the euro versus the US dollar.

Morgan Stanley is not surprised that investors are waiting to read between the lines of the US/China meeting, given global trade tensions have been blamed for the slowdown in growth. Moreover, the size and structure of cross-border capital flows as well as global trade provide indications on the health of the global economy.

This is where an alarm is being sounded by the foreign direct investment flows into Europe, which has been a net provider of foreign direct investment to the world.

The swings have been so significant that the scaling back of activity by international corporate investors is consistent with the global economy moving into recession and, as a result, Morgan Stanley suspects this could push the Fed into considering additional easing measures that will weaken the US dollar.


Deflationary pressures across the grocery market continue to ease in the first quarter, UBS notes. The broker's study reveals this stemmed from fresh inflation and weakening dry goods deflation.

Both Coles ((COL)) and Woolworths ((WOW)) appear to have experienced inflation in food in the September quarter. UBS concludes an improving inflation backdrop is positive for the sector and there is scope for stocks to re-rate further if these trends continue.

Metcash ((MTS)) is expected to be the biggest beneficiary of a return to dry goods inflation and remains the broker's preferred pick in the sector. Coles is the least preferred, given an expected risk to near-term earnings. UBS assesses the grocery market is rational and pricing is improving while ranges are not being reduced as retailers focus on differentiation.


JPMorgan suggests Australian Real Estate Investment Trusts (A-REITs) will experience pressure on rates of return amid a softening outlook for rental growth. Based on lower assumed 10-year rental growth of 3.5% per annum in Melbourne and 3.0% per annum in Sydney, the broker believes current acquisition yields are in the high 5% range and rates of return are likely to expand 30-60 basis points over the medium term before falling back to a 6-6.5%, deemed fair value.

The Sydney and Melbourne office markets have been global outperformers, delivering capital growth of around 110% since 2013. However, the broker believes the cycle is maturing, with Sydney's net effective rental growth slowing to 1.4% in the year to September versus 12.5% a year earlier. Melbourne growth has been more resilient at 6.2% in the year to September.

Demand has also tapered off, particularly when technology and flexible workspace providers are excluded, while sub-lease space has increased in Sydney. Historically, JPMorgan notes, this has been a strong leading indicator of future capital growth and if sub-lease space continues to grow this could lead to a correction in rents, yields and capital values. While supply remains significant it is balanced by low vacancy rates and high pre-commitments.

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