The Wrap: Bushfires, Coronavirus & Kaufland Exit

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Weekly Broker Wrap: bushfires, coronavirus, Kaufland, building materials, and global wild cards.

-Bushfires increase potential for an RBA rate cut and downgraded economic outlook
-Economic impact of coronavirus dependent on seriousness and duration of outbreak
-Kaufland exit suggests food inflation is likely to persist
-Brokers see value in building materials stocks exposed to the US
 

By Eva Brocklehurst

Bushfires

The value of insurance claims for the recent catastrophic bushfires is approaching that of the 2009 Black Saturday bushfires. UBS estimates this could drag on Australia's GDP by -0.25% per quarter for the fourth quarter of 2019 and first quarter of 2020.

The sectors likely to be hit hardest include agriculture, retail, tourism and construction, although the impact is difficult to determine. The federal government has announced a $2bn relief package over three years with an indicative $500m to be spent this financial year. The expected budget surplus of $5bn is unlikely to be at risk.

UBS believes stocks with exposure to retailing, insurance, food & beverage and transport will sustain the largest negative effects while resources, building materials and infrastructure are likely to be marginally affected.

Overall, UBS suspects the bushfires increase the likelihood of an official rate cut from the Reserve Bank of Australia in February and expects a reduction of -25 basis points ahead of the downgrade to the economic outlook in the February statement on monetary policy.

Coronavirus

Chinese stocks have fallen over the past two days as market participants become increasingly aware of the potential economic damage of the coronavirus. Ultimately, Commonwealth Bank analysts believe the economic impact will depend on both the seriousness and duration of the outbreak.

So far there is no vaccine for the virus. The situation has been aggravated by hundreds of millions of Chinese travelling around the Lunar New Year between January 24 and January 30. This could accelerate the spread of the virus.

The analysts believe there are some reasons for optimism compared to the SARS outbreak in 2003. SARS caused a temporary recession in Hong Kong because of its heavy reliance on tourism and trade, although the coronavirus outbreak could exacerbate Hong Kong's recent economic slump caused by the China/US trade dispute and social unrest.

However, this time around the most-affected local economies are relatively small. Hubei province, where the outbreak was first noted, accounts for only 4% of national GDP. Secondly, China's health system has improved since 2003 and experience has been gained in dealing with SARS and the outbreak of bird flu in 2013-14.

The analysts believe the virus will have little direct impact on industrial production and investment because factories and construction sites are likely to be shut during the period. Retail sales and food inflation are the main indicators to watch to measure the impact on consumer spending.

Nomura expects increased downward pressure on China's growth, particularly in the services sector if the infection rate expands. Despite a large deterioration in the services sector, the analysts agree the adverse impact of SARS was less severe on industrial production, property, exports and fixed asset investment.

The main focus for the near term is around new infections and whether mortality rates change. If not then Nomura expects the market will increasingly shift back to focus on an economic and semi-conductor recovery.

If mortality is worse then markets will focus on what happened with SARS. Back then there was significant selling pressure in equity markets and currencies were sold off against the US dollar while interest-rate curves in Asia flattened.

Under similar conditions, Nomura would expect most of the pressure would be concentrated on the renminbi and Korean won. If infections expand in the region then the Singapore dollar and Thai baht could suffer.

If the disease cannot be contained in the short term, UBS expects China's retail sales, tourism and travel-related activities will be hit. Forecasts of growth rebounding would then face some downside risk. However, importantly, the broker believes China has learnt valuable lessons from the SARS outbreak.

Kaufland

While the gap Kaufland was filling was never obvious, the decision to exit Australia before opening its first store was a surprise to brokers, given the size of the company's investment. However, the planned roll-out had often been delayed, most recently to 2021.

Therefore, this is a significant positive for the incumbents in the industry. Woolworths ((WOW)) was considered least likely to lose share to Kaufland whereas the independents, supplied by Metcash ((MTS)), and Coles ((COL)) were considered vulnerable.

The main positive is food inflation is likely to persist. Ord Minnett points out the reason dry grocery inflation has ended is that Woolworths allowed it to happen in the first place, to offset rising labour costs and any execution issues with its new model and distribution centre.

Morgan Stanley suspected Kaufland would have limited impact until it reached a critical mass of around 20 stores by FY23 and considers Woolworths best positioned to realise operating leverage over the medium term.

Citi had expected Kaufland would drive competition across private label products, primarily against Aldi, which would then affect Woolworths and Coles. Hence, the withdrawal reduces the risk to long-term earnings margins.

Citi believes the Australian grocery industry will remain highly consolidated as barriers to entry are high, particularly around securing a consistent supply of fresh categories and finding well-located sites. Moreover, Australia is no longer the global outlier on margins it once was.

Building Materials

While trading multiples across the building materials sector have jumped over the past 12 months, helped by falling interest rates, Ord Minnett finds some value still exists. Key variables for James Hardie's ((JHX)) North American division, such as housing demand and input costs, remain supportive.

The broker expects the upgrade cycle will continue and the stock remains the sector preference. Ord Minnett also has an Accumulate rating for Reliance Worldwide ((RWC)), noting early signs of improvement in the UK. The broker likes the fact the stock is relatively defensive with a structural growth dynamic such as the ageing housing stock in the US.

On the other hand, Ord Minnett assesses Boral's ((BLD)) guidance for FY20 is too optimistic and a downgrade is expected as the year progresses. Earnings (EBIT) in the second half for CSR ((CSR)) should decline significantly, in the broker's view, as commencements are expected to stabilise near current levels rather than rebound to the highs seen over 2015-17, with the share price of CSR appearing to factor in the latter.

Citi assesses James Hardie, Boral and Brickworks ((BKW)) are leveraged to a US housing market recovery and James Hardie is the top pick. Housing starts in the US in December were up 41%, to the highest level in 13 years. Of the three stocks, James Hardie provides the highest leverage, with its US business accounting for 76% of FY21 operating earnings forecasts.

Global Wild Cards

Citi reviews the wild cards for 2020. The US/China trade relationship looms large and President Trump and his policies dominate several issues. This is not only in the economic challenges to China and to multilateralism, which allowed trade flows to fall into negative territory in 2019, but also across large areas of the world.

The retreat of the US from globalism and global rules looms large, in the broker's view, as does the rise of China and the implications for trade and investment. The stand-off between the US and Iran and disruption risks to the oil market appear particularly large.

The probability that a deal will be reached and sanctioned oil is brought back to market, with prices below US$50/bbl, is considered very low. There is also a low probability of a surprise US recession in the second half of 2020, in Citi's view. Markets are pricing in a soft landing in the US despite the persistence of weak manufacturing.

Environmental and social issues are also affecting how the year will unfold in many commodity-producing countries and emerging markets. This is putting pressure on cost curves and creating the potential for widespread problems ahead.

High on the broker's probability list are expectations the EU will ramp up its de-carbonisation policies, while social instability will become a prominent source of commodity supply disruptions.

In contrast, Citi considers there is a high probability of a protein shortage in China, with food inflation soaring. This stems from the outbreak of African swine fever in China, which has spread across every province. China will need to increase imports of pork for the next several quarters, perhaps to the benefit of the US, Brazil, EU and Oceania producers.

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