The Wrap: Banks, Retailing And Waste

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Weekly Broker Wrap: banks; retail & consumers; and waste.

-Regional banks most affected by the latest cut to the RBA cash rate
-Coronavirus spread puts further pressure on banks, retailers
-Decline in tourism-related business could weaken Australia's already soft consumption growth
-Victoria's waste management proposals likely to be favourable in the medium term for listed stocks
 

By Eva Brocklehurst

Banks

The latest reduction in the cash rate, which is now at a record low of 0.5%, will have a significant knock-on effect on the earnings outlook for banks. Macquarie assesses a -5% impact on bank earnings and even a -9% hit for Bendigo and Adelaide ((BEN)). Following the reduction in October, banks had indicated that fully passing through additional rate cuts was not feasible.

Yet, it appears they lack the required political capital to stare down the government's call and avoid passing on the latest reduction to customers.

Regional banks are most affected and Macquarie expects they will smooth the impact through re-pricing initiatives but suffer more churn in the medium term. Amid a growing risk to earnings from slowing economic activity, the broker retains an Underweight view on the sector.

JPMorgan had assumed the banks would hold back around one third of any cash rate reduction and agrees Bendigo & Adelaide is the most exposed. Rate cuts also make it increasingly difficult to manage deposit spreads effectively.

Hence, there is further pressure on pay-out ratios and it raises the prospect of more cuts to the dividend. JPMorgan economists expect a follow-up cut to the cash rate of -25 basis points in April and for the banks to pass through two thirds.

UBS also expects another, final, reduction in April and agrees returns for the banking sector are likely to fall towards single-digits, placing further pressure on capital and dividends. The broker does not believe current interest margins and returns on equity are sustainable.

Meanwhile, the spread of coronavirus is creating a pronounced impact on global growth and Morgan Stanley asserts there is rising pressure to cut rates further as a result.

The broker forecasts another cut in April and again in August and increased disruption could bring the latter forward to the June quarter. The flow-on effect will mean more margin pressure for the banks while the likelihood of higher loan losses increases, stemming from the impact of coronavirus on the tourism, education, retail and wholesale sectors.

Among the major banks, Morgan Stanley believes Westpac ((WBC)) has most exposure to affected industries and Commonwealth Bank ((CBA)) the least.

There is now the potential for a serious consideration of quantitative easing. JPMorgan believes this reinforces pressures on net interest margins in the medium term while Macquarie Group ((MQG)) appears best positioned to benefit from QE.

Retail

ANZ Bank economists note early indicators of retail expenditure by tourists and locals point to a weak March quarter for retailing. The reduction in outgoing travel may soften the impact of tourism on retail but a decline in tourism-related employment could weaken Australia's soft consumption growth.

Despite an improvement in retailing in the December quarter, retail volume growth is likely to be modest in 2020, particularly if coronavirus concerns escalate or if food prices continue to rise relative to the CPI.

Coronavirus is not only affecting retail through the impact on travel but also because some are electing not to dine out and are avoiding crowded areas. The economists point out, even without the disasters of the bushfires and the spread of coronavirus, retail sales were always unlikely to sustain the December quarter trajectory.

Per-person retail data shows that the average household is buying less over time and nominal expenditure on anything other than groceries, pharmaceuticals and toiletries is barely growing. Moreover, structural barriers to spending such as high debt, poor wage growth and the rising cost of non-retail essentials are creating limits to how much households can spend.

However, while retail stocks have sold off on the broader concern about disruption from coronavirus, Citi does not believe this translates to a lack of valuation support as there has been decent earnings growth across a number of discretionary retailers.

One changing dynamic, which Citi notes, is that retail inflation has accelerated and non-retail inflation has eased. The rate of inflation in the December quarter was above long-term trends in food, tobacco and clothing.

This comes at a time when the overall level of the CPI remains low and living cost pressures are benign, in the broker's view. The main catalyst that will encourage faster retail spending, Citi envisages, is higher house prices, faster housing churn and lower savings.

In the current environment, Morgans prefers defensive, quality retail stocks. Given the limited information available to companies at the time of the last reporting period the broker suspects the coronavirus outbreak will continue to have an impact on retailers. Those with private-label/fast fashion/high turnover models are likely to be the first to feel the pressure. In contrast, those with more of a domestic, wholesale supply base should more insulated in the short term.

Recent feedback indicates Chinese factories, outside of Wuhan, are back up and running to some extent, although there is no obvious backlog. The next potential development in the coronavirus saga is the impact on actual demand and how much pressure this places on discretionary income

Stimulus, either fiscally or monetarily, may be forthcoming but the broker still envisages a rising risk to domestic discretionary income and expenditure.

Morgans has upgraded two stocks which have de-rated heavily, JB Hi-Fi ((JBH)) to Add from Hold and Domino's Pizza ((DMP)) to Add from Reduce. The broker notes the latter experienced a trading benefit during the SARS period in its Japanese operations.

The broker also includes Bapcor ((BAP)) as one of those best placed in the larger more defensive names and has downgraded one stock, Accent Group ((AX1)) to Hold from Add.

Waste

Victoria has proposed a 10-year recycling plan that includes increasing landfill levies to $125.90/t by July 1, 2022. While the focus may be on pricing power implications of these levies, Macquarie suspects the strategy is just further confirmation of a significant shift that is underway in Australian waste management.

Victoria is also introducing a container deposit scheme starting in 2022, implementing a four-bin collection system to improve the quality of recyclable material and developing downstream markets for recycled materials.

Macquarie suspects the net impact for waste management firms such as Cleanaway Waste ((CWY)) and Bingo Industries ((BIN)) could be favourable. There is increased opportunity for investment in longer-tenure infrastructure-like assets.

The broker prefers Cleanaway, despite its exposure to landfill, for its ability to capture the growth opportunities, as value and pricing visibility prevents a more constructive view on Bingo Industries.

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