Weekly Reports | Nov 15 2019
Weekly Broker Wrap: cash rate; economic outlook; house prices; car sales; platforms; retail online; waste management; and drought.
-Little evidence to date that RBA rate cuts or tax rebates have worked
-Household goods retailers running ahead of housing upturn
-Weak car sales may reflect foreign-driven nature of housing recovery
-Reduction in cash administration fees main risk to platforms
-Coles, Woolworths expanding share of online grocery
-Cleanaway Waste in the box seat pending a Victorian CDS
By Eva Brocklehurst
Cash Rate Outlook
National Australia Bank economists have pushed out the expected timing of the next reduction to the cash rate by the Reserve Bank of Australia to February 2020 [ahead of yesterday's jobs data]. A further -25 basis points reduction would take the cash rate to a new low of 0.5%. At this level, the RBA has previously indicated it would consider unconventional policy if required.
The economists assert that the RBA should probably provide a further rate cut next month, given private sector growth is weak and there is little evidence to date that the prior cuts to the cash rate or the tax rebates have done enough.
However, the central bank appears to be paused at the moment. An improvement in growth is envisaged over time but not enough to prevent the unemployment rate rising. Moreover, the government does not appear inclined to provide material fiscal stimulus and this increases the need to ease further. The economists note the RBA governor is speaking on unconventional monetary policy on November 26.
UBS is pessimistic, expecting global growth will get worse before it gets better. This mainly reflects assumptions that any trade deal between the US and China will be limited. The broker envisages global GDP edging down to 3.0% in 2020, the weakest since the GFC, before rebounding towards trend of 3.6% in 2021.
Importantly, the automotive cycle accounts for around half of global industrial production weakness and the technology cycle around 30-40% of nominal trade weakness. Hence, amid political uncertainty, UBS does not expect a comprehensive trade deal on its own will turn the situation around.
Moreover, global employment growth has slowed towards the "stall speed" where unemployment starts to rise. For Australia, the broker remains below consensus on GDP and envisages only a modest recovery from a post-GFC low of 1.7% in 2019 to 2.1% in 2020.
UBS expects lower bond yields, with US 10-year yields falling back to a trough of 1.0% in mid 2020 and the US Federal Reserve reducing official rates three more times to under 1%. Australian yields are also expected to fall to a trough of 0.5% mid 2020, amid more cash rate cuts and the market pricing in increased risk of quantitative easing.
House prices appear to be turning up and UBS now expects a tailwind to household goods sales over FY20 as a more positive outlook on house prices and tax rebates and rate cuts offsets softer activity. It appears, nonetheless, that housing-related retailer share prices have pre-empted the move higher and outperformed the ASX200 industrials ex financials by around 33% in the past 12 months.
This comes despite little evidence of any improvement in trading. As a result, this puts pressure on retailers such as Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)). The broker remains wary that expectations are running too far ahead.
Credit Suisse calculates, in three-month annualised terms, Sydney house prices have risen by 22% and are now 5.5% above 2019 lows. Moreover, domestic demand and supply factors cannot explain the magnitude of house price increases. Turnover levels have risen but not dramatically. Investor interest has also been waning.
The broker believes Chinese and Hong Kong buying explains a lot of the conundrum. Juwai reports Chinese enquiries regarding Sydney property are up almost 90% and Hong Kong buyer enquiries up 50% since the protests started. This explains and predicts Sydney house price movements where there is a lack of local factors.
Car sales have been very weak, Credit Suisse observes, underscoring pessimism about the outlook for domestic demand. Car sales fell by -9.1% over the year to October, continuing a trend decline that started in late 2017. The broker suggests the weaker car sales relate to an uneven housing recovery.
Historically, vehicle sales have been highly correlated with house prices but recently to have diverged. The broker believes this reflects the foreign-driven nature of the housing recovery and a lack of participation among locals.
Locals are using existing vehicle assets for longer, and weakness in the construction cycle is also weighing on commercial vehicle demand.
Credit Suisse assesses the biggest near-term earnings risk for both HUB24 ((HUB)) and Netwealth ((NWL)) is a reduction in cash administration fees. The risk will not materialise, however, unless the RBA cuts the cash rate further. There is minimal impact for AMP ((AMP)) and IOOF ((IFL)). AMP does not charge additional fees on cash balances while there is some risk for IOOF if the RBA cash rate moves to zero.
Recently some North American banks/brokers moved to zero commission rates for trading stocks on online trading platforms. This may take some time before it is replicated in Australia, if at all, but the removal of these fees could represent a -10-30% risk to net profit for HUB24 and Netwealth, in the broker's view.
The low interest rate environment has also led Macquarie to further assess cash accounts on platforms. Focusing on the proportion of cash as a percentage of funds under administration, the broker sees downside risk potential for cash balances. Risk emanates from advisers positioning the excess cash of clients in higher yielding substitute products and away from the default cash account.
Given the high relative percentage of cash and superannuation funds, there are risks to the cash margins generated by the platform operators, particularly when the net fee outcome is negative for members. The broker reaffirms an Underperform rating for both HUB 24 and Netwealth.
Australian grocery retailing is developing online and Coles ((COL)) and Woolworths ((WOW)) enjoy a higher share of the online business vs overall share of the grocery market. JP Morgan suggests online growth is likely to be dilutive to earnings (EBIT) margins while the store network and store size are optimised.
Online sales consists of around 2-3% of grocery retailing in Australia, forecast to be 3.7% by 2023. The broker suspects this estimate may be conservative as growth rates are high and online is likely to augment the existing strategic positioning of Australian retailers.
The partnerships chosen by the pair reflect respective online capabilities. Ocado, chosen by Coles, provides a total solution with lower picking costs but larger capital expenditure in centralised locations. Significant improvement in the offer from this source is unlikely to occur until FY23, JPMorgan contends.
Woolworths is adopting a more varied approach and ceded less control, with Takeoff allowing it to be closer to the customer albeit with higher picking costs.
Australian environment ministers have agreed that an export ban on waste such as plastic, paper, glass and tyres that have not been processed into value-added material should be phased in over the next two years. State governments have also agreed to a plan which sets out a National Waste Policy and targets.
JP Morgan believes, over the longer term, this development will be positive for waste management operators with scale that can deploy capital across a larger, more harmonised market.
Banning the export of certain materials for recycling will affect a number of business models but also lead to increased recognition of the real cost of recycling, likely forcing higher costs back onto the consumer.
The broker considers it likely that the Victorian government will implement a container deposit scheme. This would reduce the volume of recycled material. As Cleanaway Waste ((CWY)) operates the NSW container deposit scheme and now owns the SKM assets, JP Morgan suspects it will be in a good position to get involved in the Victorian market.
JP Morgan notes agricultural conditions in Australia remain challenging with national annual rainfall in the year to date the lowest in a century. Hence, price pressures are emerging in most agricultural-exposed sectors, although broader inflation pressures remain benign.
Farm output and income have turned down sharply and further declines are expected in the next 12 months. While fiscal support may help, the broker suggests it will not be enough to offset the anticipated drag on GDP.
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