The Wrap: Recovery, Correction And Healthcare

Weekly Reports | Jul 31 2020

Bounce in crisis recovery has been sharp but underlying conditions remain patchy; global manufacturing expected to be below pre-virus levels until mid-2021; potential new revenue streams for healthcare companies

-FY20 results expected to drive a correction in the ASX200
-Labour-intensive manufacturing industries worse off due to the pandemic
-Integration of technology with healthcare to drive sustained growth 

By Angelique Thakur

A million-dollar question

The shape and pace of the post-covid recovery is a topic of huge interest and widely varying views. And for good reason. The path to recovery is important for discerning the outlook for the economy. Key sectors like banks, consumer and property are especially exposed to how the recovery plays out, comment Morgan Stanley analysts.

Morgan Stanley’s AlphaWise survey, which covers 1530 households, discloses that while consumers anticipate a recovery in the coming times, they are also under financial stress. The risk stemming from this is enough to weigh on the outlook, the survey finds.

Morgan Stanley’s recovery path base case sees activity levels coming back to pre-covid levels by the end of 2021. That is if there is no further delay in reopening/social easing.

The risk of lockdown 2.0 poses significant downside risks to the recovery, and the sectors that are considered most vulnerable are banks, retail and property.

For banks, the loan loss cycle is a major pain point and how it unfolds will impact their profitability materially. The survey highlights about 72% of mortgagors are worried about their financial position.

Out of mortgagors who are currently deferring home loan repayments, about 10% want to extend the deferral period. This looks more prevalent among older borrowers, owner-occupiers and households with income between $90k and $140k, according to the survey. Morgan Stanley reports there are quite a number of mortgage customers who appear to be very highly vulnerable in case of income support removal. 

The analysts think ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) are more vulnerable than Commonwealth Bank ((CBA)) and Westpac ((WBC)). Bendigo and Adelaide Bank ((BEN)) also looks less vulnerable than Bank of Queensland ((BOQ)) and the major banks.

Retailers have generally gained from pandemic-induced trends, the question, asks the survey, is how long these trends will persist.

Morgan Stanley prefers Coles Group ((COL)) over Woolworths ((WOW)) as a purer play with a better dividend yield. The broker is also Overweight on Metcash ((MTS)) due to its exposure to food, liquor and hardware (helped by a strong balance sheet). Super Retail Group ((SUL)) is the preferred discretionary retailer.

The survey suggests the pandemic has brought online sales forward by about three years. However, this shift to online sales in retail may not necessarily be permanent, considered good for Scentre Group ((SCG)).

The outlook on the property sector is mixed with 35% of respondents stating they would like to work from home full-time. In residential, 21% of the participants are planning on purchasing a property in the next 12 months versus the usual 33%-38% historical range. The HomeBuilder stimulus is making a difference which is good for Stockland ((SGP)).

FY20 results will bring clarity around actual impacts to earnings, cash flow and dividends. This will act as a catalyst for a correction in the ASX200, in the broker's view. Morgan Stanley expects the markets to retrace to 5500-5700, suggesting -5-10% downside. This would make for a better entry point. The analysts currently have a 12-month target of 6200.

Expecting a market pull-back along with a far from smooth earnings season, Morgan Stanley adopts a cautious stance.

The broker moves away from Qantas Airways ((QAN)), Adbri ((ABC)), Brambles ((BXB)) and Dexus Property Group ((DXS)). It suggests more of Crown Resorts ((CWN)), Cleanaway Waste Management ((CWY)) and Metcash. Macquarie Group ((MQG)) and Qantas Airways are replaced with Crown Resorts and Cleanaway Waste Management in its Focus List.

Global supply chains: Out of sync

A study by Oxford Economics finds global industrial production for May was up 2.3% (month on month), confirming April was the low point. With economies reopening, it looks like the world is slowly heading towards recovery.

However, we have a long road ahead of us, with global manufacturing expected to remain below its pre-virus levels until mid-2021. Even then, the recovery path will not likely be straight and smooth. 

Oxford economics expects restrictions on high-contact services like travel, recreation, accommodating and catering to have a spillover effect on the manufacturing firms supplying goods to them. Aircraft manufacturing, jet fuel refineries and their suppliers are facing a weaker recovery trajectory, with air travel restriction easing at a slower pace. In fact, passenger demand will not likely surpass pre-covid demand until 2023.

The pandemic has also brought to the fore higher vulnerability of people-intensive production processes.

In labour-intensive manufacturing, new procedures like social distancing and cleaning practices have impacted labour productivity. One example is the meat-processing industry where virus outbreaks among factory workers have led to temporary plant closures across Europe and the US.

Capital intensive production processes, like petroleum refineries, chemicals and automotive, are better placed to adapt to social distancing. This, feels Oxford Economics, could encourage companies to invest more in machinery and automation rather than in people, during the recovery.

If there is one thing the pandemic has thrown light on, it is the fragility of the global supply chain. Synchronising global supply chains has become extremely difficult given the varying paces at which different countries are easing restrictions. This will remain difficult until the world manages to contain the virus.

This has also made us painfully aware of the current concentration of supply chains to a few key manufacturing hubs. This lack of diversification could slowdown recovery in case of another outbreak, warn the economists. That is especially true for sectors where a small number of economies comprise the bulk of the international supply chain. Some examples are textiles, electronics and aerospace.

That also does not imply we should resort to protectionist policies, cautions Oxford Economics, by re-shoring production to reduce reliance on foreign suppliers. This, it states, will not really eliminate the risks but would concentrate them domestically while reducing comparative advantage.

The solution is to diversify supply chains, stock more essential products domestically and increase the foreign supply sources.

All in all, aerospace is considered the most vulnerable (no surprises there). On the other hand, pharmaceuticals, food, beverages and the chemical sector look well placed to recover backed by their essential nature (especially pharmaceuticals, food and beverages), well-diversified supply chains and stronger financial positions before the pandemic.

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