Weekly Reports | Jul 10 2020
Victoria is under lockdown, the US is heading for an income shock, people are buying more SUVs and a recovery is on the cards for Australian casinos
-Lockdown in Victoria to dampen recovery while teaching us a few lessons along the way
-Consumer durable stocks appear to be fully valued
-A shift towards SUVs and 4X4s
-Income shock post-July with CARES Act ending
By Angelique Thakur
Stage three covid-19 restrictions imposed across metropolitan Melbourne, essentially requiring people to stay at home for the next six weeks, depict the virus recovery process will not be linear and will more likely than not encounter hurdles.
While Morgan Stanley does not expect the latest outbreak to lead to the share market lows seen during the first wave, there will be repercussions.
Victoria represents about 25% of Australia’s economic activity and employment, and a six-week lockdown is sure to impact economic data. The broker predicts a direct impact of -1.2% to the third-quarter GDP, translating to a hit of -$5bn.
Consumer sentiment is crucial in how this lockdown plays out. While Morgan Stanley expects spending to reduce, the extent may be less than what it was the last time due to stimulus measures providing a degree of support along with a definite timeframe for the lockdown.
Wilsons notes Adairs ((ADH)) has the largest exposure to Victoria among small cap retailers, followed by City Chic Collective ((CCX)), Nick Scali ((NCK)) and Mosaic Brands ((MOZ))
In fact, store sales form more than 60% of Adairs revenues and for every week the stores remain closed in Victoria, it could imply a loss of -$1.7m, states Wilsons.
Believing peak investment in the home may already have occurred, Wilsons expects household categories to see demand moderating.
In the food and clothing category, Wilsons expects an adverse impact on winter stock which could lead to some clearance activity.
Morgan Stanley expects an increase in businesses closing shops permanently, especially the small, less liquid ones. This will not only slow down the recovery but also reduce capacity once lockdown measures are removed.
The housing market is basically demand-driven with headwinds to the economy likely to translate to headwinds in the housing market. Melbourne has accounted for 17% of housing sales over the year to date, and the ban on live auctions and house inspections implies a meaningful headwind to national turnover.
Government support measures have been crucial in sustaining activity over the last few months. Already amounting to $135bn, the total measures form 14% of GDP over the six-month period.
Morgan Stanley estimates support measures directed towards households have boosted household disposable income by almost $85bn or 13% over the six-month period.
While originally most of these measures are set to expire in September, Morgan Stanley expects the government to continue to provide strong counter-cyclical support to the economy, its strong budget position giving it the needed fiscal space.
The banks have already extended payment holidays for another four months and Morgan Stanley expects more support in housing skewed towards first home buyers.
Companies, noting the fluidity of the economic environment, may focus solely on FY20 results in their updates and refrain from giving out definite guidance.
The broker expects downside risks to earnings estimates (already impacted by covid-19) for FY21 but is more worried about FY22. With many companies assuming FY22 will see a return to FY19 levels, a slowdown in recovery will test this assumption.
Morgan Stanley expects investors to have a greater appetite for defensive stocks with the focus turning to profitability, leverage and earnings stability.
The optimism surrounding the re-opening of the economy had assumed a linear and strong recovery trajectory post-crisis, notes Morgan Stanley, but the situation in Victoria is a reminder that recovery milestones may not be so linear after all, and are subject to delays.
Victoria’s experience in dealing with this outbreak will be extrapolated to all future outbreaks, which is why re-flattening the curve assumes even more importance. How Victoria deals with this will affect the reaction of other states in terms of lockdowns and border closures.
Is the party over for consumer discretionary stocks?
The earlier national lockdown restrictions led people to increase spending on home renovation and home appliances. Now, with restrictions easing, consumers are staying less at home, which means a diversion of spending away from the household goods segment.
Another factor bound to impact spending is the winding down of short-term demand catalysts such as JobKeeper payments.
Macquarie feels while the focus on consumer durables will continue to remain high, the early wins from holding these stocks have already occurred and the best is over.
The broker cautions against using FY20-21 as a base case for calculating sustainable earnings/valuation, stating this will lead to disappointment. The ideal thing to do, suggests Macquarie, is to consider FY22 as a base for a sustainable growth platform.
Moreover, Macquarie considers consumer discretionary stocks to be fully valued. It expects Bunnings’ ((WES)) sales to decrease with the resumption of normal activities and also notes supply chain constraints at Target and Kmart.
Domino's Pizza Enterprises ((DMP)) is expected to be affected by the reopening of restaurants and bars. JB Hi-Fi’s ((JBH)) sales are expected to decline with the outlook uncertain for discretionary spending, while The Good Guys’ high exposure to housing makes the valuation already look stretched.
Macquarie has downgraded Wesfarmers ((WES)), JB Hi-Fi and Domino’s Pizza Enterprises to Neutral with a preference for staples over discretionary.
Harvey Norman Holdings ((HVN)), Coles Group ((COL)) and Woolworths ((WOW)) are rated Outperform.
Playing your cards right
Australian casinos are reopening with limited restrictions and high capacity. Citi is positive about the near-term revenue prospects from these casinos, driven by pent up demand, government stimulus measures and wage subsidies.
The JobKeeper wage subsidy will likely aid Star Entertainment Group ((SGR)) and Crown Resorts ((CWN)) to ramp up service levels while increasing first-half margins by circa 7bps.
This leads Citi to expect higher gross gaming revenues (GGR) across the Industry, although still down from the FY19 levels.
Only Crown Resorts Melbourne remained closed at the end of the first week of July, owing to a resurgence in cases. This brings us to Citi’s main concern which is the extent of the recovery, especially given income pressures and border closures.
Citi prefers Star Entertainment Group over Crown Resorts because of Star's earlier reopening along with an attractive valuation. Citi increases its FY21 operating income estimates for both to reflect the better demand-supply outlook.
Star is upgraded to Buy while Crown has been downgraded to Neutral driven by further delays in Melbourne’s reopening.
Shifting gears: A move towards SUVs and 4X4s
Citi’s proprietary ARB Corp ((ARB)) sales index grew by 6% in June, the first positive month since March 2019. The increase was driven by an uptick in ARB’s key segments of large/upper large SUVs, 4X4s and heavy commercial vehicles.
Citi analysts highlight these segments got a boost from the Federal Government’s accelerated depreciation scheme (which allows businesses to write-off new assets up to $150,000) and the lockdown-induced pent-up demand.
Citi expects the accelerated depreciation scheme to support sales during the first half of FY21.
However, the broker advises caution as it considers the sales in June to be on account of the pent-up demand rather than an indication of a return to stability. Also, the broker is worried these sales may have depleted showroom stock and may lead to a shortfall in stock (given factories have been shut down during the covid-19 disruption).
Citi’s third concern is related to JobKeeper which is set to finish in September, and expected to impact spending. Where the use of SUVs and 4X4 is increasing, new car sales declined by -6% year on year in June.
UBS considers this to be an improvement over the last months with May down -35% and April down -48%, although noting this decline is the 27th consecutive decline.
June saw the emergence of a two-speed market with higher sales of luxury cars with key brands of Autosports Group ((ASG)) like BMW, Audi, Mercedes and Volvo seeing strong growth.
This seems to be supported by people reallocating expenditure away from travel and entertainment and moving away from public transport along with fiscal stimulus measures, pent-up demand and the asset write off expansion extended to December 31.
UBS remains cautious about FY21 due to an uncertain economic backdrop, tapering off of stimulus measures and tighter credit conditions.
The decline in new car sales bodes well for Bapcor ((BAP)) and GUD Holdings ((GUD)) as Citi expects demand for servicing to increase. Older vehicles are more likely to be serviced by independent garages with whom both the companies have strong dealings.
Citi also notes weaker sales in brands that offer longer warranties (Kia), again a positive for Bapcor and GUD Holdings.
Bapcor, with less discretionary products as compared to ARB Corp ((ARB)) and a clearer long-term growth plan compared to GUD Holdings, remains Citi’s preferred choice.