Weekly Reports | Sep 04 2020
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The second wave in Western Europe may not be as deadly as feared; industrial and office REITs collected more rent than discretionary malls; policy measures are preventing a steeper decline in house prices
-Covid-19 in Western Europe: A ripple rather than a wave
-REITs: Faltering rent collection in discretionary retail
-Housing prices: A long way from home
-By Angelique Thakur
Herd Immunity Threshold – Achieving Nirvana
Western Europe is currently the epicentre of the second wave of coronavirus cases with many countries recording major spikes since July 1, 2020 (Spain – 1900%, Ireland – 900% and Netherlands – 500%).
But simply looking at the raw numbers can be misleading, as Bell Potter's analysts have found out. They suggest the sharp rise in the number of cases is more due to an increase in testing rates than a higher number of people testing positive.
Which gets us to another point – fatality. Bell Potter has found the number of deaths has not kept pace with the sharp “rise” in cases. Simply put, there is a mismatch between cases and deaths with deaths too low.
One of the things this may point towards, suggests Bell Potter, is the massive undercounting of case numbers in the first outbreak.
To understand this better, the analysts crunched some numbers based upon the number of deaths recorded. The results were mind-boggling. If what the analysts suggest is true, instead of the 30,000 cases recorded per day (at peak levels) in the first outbreak in Western Europe, the actual Western European cases may have been running at over 500,000 per day at their peak!
This takes the sheen off the current outbreak, rendering it as little more than a ripple, let alone a wave, Bell Potter suggests.
It may also appear the original assumptions about herd immunity may have been incorrect and we may be much closer to achieving herd immunity than we might think. Bell Potter believes much of Western Europe and the USA have likely hit herd immunity thresholds (HITs).
This is based on studies that suggest a 10-20% infection rate may result in HITs being reached for covid-19 as opposed to the conventional 60-70% infection rate. This is further supported by studies showing widespread pre-existing T-cell immune responses to covid-19 in up to 80% of individuals.
In a nutshell, Bell Potter feels life in Western Europe and the USA will return to normal by the year's end, with herd immunity broadly obtained.
Continuing on the same topic, Citi analysts have tried to answer how life may change post-covid. For starters, Citi suspects some changes will be fleeting while others will hold sway for a long time. A case in point is the belief the game was over for cruises, a notion negated by the rise seen in bookings for 2021.
Citi highlights other changes, like the rise of telemedicine, will have longer-term implications. Another area is business travel, expected to see a -10%-20% reduction with companies learning how to engage effectively via virtual meetings over the last few months.
Moreover, a shift away from city centres may also be in the offing. Considering the stigma of working from home over, the analysts expect a shift towards suburbanisation, which may lead to more housing activity and the need for vehicles.
The analysts feel income inequality will ultimately lead to higher taxation and pushback on immigration and imports. Anti-globalisation efforts will likely hinder profit margin expansion as access to cheaper overseas labour diminishes.
REITs’ rental woes
Morgan Stanley's June quarter rent collection stats show Industrial and Office REITs had fewer issues with converting billings to cash flows than their discretionary retail peers. In particular, Goodman Group ((GMG)) and Charter Hall Group ((CHC)) offer growth and earnings prospects far more resilient than peers, highlights Morgan Stanley. The analysts also like Dexus Property ((DXS)) which, despite earnings challenges, is likely to deliver cash earnings and minimal write-offs.
Across stocks covered by Morgan Stanley, 69% of uncollected rent was expensed in the form of waivers and provisioned credit losses. However, the various approaches taken by the REITs to account for uncollected rent makes profit recognition a difficult, if not slippery, process.
A case in point is the July rent collection of Scentre Group ((SCG)), reported at 82%, a stark difference from Vicinity Centres' ((VCX)) 47%. On closer inspection, the analysts found Scentre Group had included billings from previous months as part of its July rent collection. If the same method is applied to Vicinity Centres, its July rent collection increases to circa 75%.
Morgan Stanley found GPT Group ((GPT)) and Vicinity Centres to be the most conservative in terms of profit recognition of uncollected rent.
The analysts contend the Melbourne lock-down will be a setback for REITs like Vicinity Centres with considerable exposure to Victoria (45% of income).
Preferring to adopt a conservative stance, a rent collection rate of 70% has been assumed for major retail REITs such as GPT, Vicinity, Scentre Group, Mirvac ((MGR)) and Stockland ((SGP)) in the December half.
Policy propping up prices
National house prices fell another -0.5% in August and are -2.5% down from their April peak. Leading the way was Melbourne which saw a fall of -1.2% month on month (-4.7% from peak levels). Sydney and Brisbane were more resilient at -0.5% and -0.1%.
Policy support for housing market participants will continue to be provided until 2021 which Morgan Stanley believes will help contain some of the housing stress this spring selling season. With Melbourne expected to ease restrictions in the coming months, price declines are expected to moderate even more.
But this does not mean all is well. The analysts still expect a challenging scenario for the rest of the calendar year. July building approval levels, while better than before, are low and hint at a reduction in construction levels in the coming months. Since the sector makes up over 10% of employment, Morgan Stanley fears this will also impact the labour market.
Led by the impending removal of the support measures, muted immigration activity and sluggish credit supply, market conditions will likely remain subdued through 2021, Morgan Stanley concludes.
Retail sales growth expected to slow down
Driven by the government stimulus, household income grew 8% in the June quarter (year on year), ensuring Australian households had one of the strongest quarters in income growth for many years.
However, excluding the support, the picture was pretty grim with household income falling by -9%.
While the September quarter looks equally encouraging, led by government support, the retailers are faced with the question of what would happen in the December quarter and beyond when the stimulus fades away.
Citi analysts studying the scenario expect cash flow to households to slow down materially. This in turn will hit retail sales with growth expected to slow down to -1% in the December 2020 quarter from 2%-4% in the June and September quarters.
Also, as restrictions ease, consumers will likely redirect more spending outside of retail, suggest the analysts. What remains to be seen is how far households draw down on savings.
Citi analysts expect sales growth to inevitably moderate with the September 2020 quarter to be the peak of sales momentum. Momentum will soften over the December 2020 quarter and then further into 2021, they assert.
In such a scenario, Citi’s preference remains for grocery over discretionary retail. For discretionary retail, Citi prefers companies pricing in less optimistic FY22 earnings like Super Retail ((SUL)) and Harvey Norman ((HVN)), rated as Buy by the broker.
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