The Wrap: Gambling, REITs & Tax Breaks

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Weekly Broker Wrap: Increased online gambling frequency during covid; no light at the end of the tunnel for office REITs; September rise in number of businesses entering into administration.

-Betting on it: Findings of a covid-19 gambling survey
-Office REITs: Still on a downhill slide
-Budget tax break: All bark some bite?
–Administering the right medication

By Angelique Thakur

The worst is yet to come

Office REITs continue to be deep in the doldrums with both Macquarie and Goldman Sachs expecting CBD office market vacancy rates to rise to almost 12% for both Sydney and Melbourne.

According to the September quarter data released by Jones Lang LaSalle, CBD office market vacancy exceeds 10% for Sydney and is above 11% for Melbourne.

The first nine months of 2020 have seen the biggest ever collapse in office demand in Sydney and Melbourne sine 1970. 

The quantum of demand contraction is more severe than Goldman Sachs anticipated and has prompted net absorption to fall by -221,000 square metres in Sydney and -121,000 square metres in Melbourne for the year. Macquarie analysts also admit the magnitude is more than expected.

The collapse has seen a decline in net effective rents. To the casual eye, it looks like rents have increased but when adjusted for incentives, Macquarie finds all regions have reported a decline in net effective rents over the last three months.

Taking the lead is Sydney with prime net effective rents dropping -11% on a quarterly basis. The fall was led by a jump in incentives which have grown to circa 29% versus June’s 23%.

Going forward, Goldman Sachs expects rents to decline by more than -40% (peak to trough) in both the markets. Macquarie seconds this and expects more is in store as far as incentives are concerned.

In fact, Macquarie feels a fall in face-value rents would be inevitable for some geographies including Sydney, pegging the effective rent decline between -20-30% for the city.

Unsurprisingly, asset values in the Sydney and Melbourne markets have also softened over the June quarter. These are expected to continue to decline by -5-15% due to lesser expected income and will cause cap rates to increase. Cap rates for Sydney prime assets increased 19bps to 4.7% and have increased to 6bps to 4.9% in Melbourne over the quarter.

The third-quarter data was disappointing and below either broker’s expectations. However, it looks like the worst is yet to come.

Office REIT demand is expected to be negative in the short term with supply still to come, putting pressure on net effective rents. And this is when the impact of working from home on future demand hasn't even been included.

Unsurprisingly, both Macquarie and Goldman Sachs are cautious on the cashflows of listed office REITs.

Goldman Sachs acknowledges Dexus Property ((DXS)) has positioned itself well for the deteriorating environment.

The REIT is doing the right things  – like flagging asset sales and constituting an Opportunistic Fund. However, there is no hiding from the fact the REIT remains overwhelmingly an office market play, warn Goldman Sachs analysts. 

Furthermore, the REIT’s share price performance has tended to track net effective rents in Sydney. Goldman Sachs has decided to give this one a miss and maintains its Sell rating.

Goldman is not any more positive on Charter Hall Group ((CHC)) and believe consensus expectations seem to be overestimating the rate of transitional activity while underestimating the negative impact of a downturn in office capital values on the REIT’s funds under management base. 

Charter Hall Group is rated as Sell.

Mirvac Group ((MGR)), given its relatively young portfolio and limited lease expiry risk over the next few years, is Goldman Sachs's preferred office exposure (rated Neutral).

Macquarie is a tad more optimistic, rating both Dexus and Mirvac as Neutral. GPT Group, with 40% exposure to the office market, is Macquarie's pick and is rated Outperform.

Rolling the dice

More Australians turned towards online gambling during the covid lockdowns. A survey by the Australian government confirmed what Macquarie suspected all along. The report, titled "Gambling in Australia during covid-19" was based on a survey of 2019 people to understand their gambling habits.

Cooped up inside their homes, more people resorted to gambling as a form of entertainment, finds the report. Wagering products were the biggest beneficiaries with one in three participants opening a new wagering account, followed by rising lottery volumes.

Unsurprisingly, gambling frequency saw a spike with 32% of the respondents gambling more than four times a week versus 23% pre-covid.

The report revealed people in the 18-34 age bracket saw the most increase in their gambling habits. Men in this category increased their average expenditure by 57% while women emerged as the saner lot, increasing their spending by only 30%.

The frenzy did not extend to people above 35 years of age who in general saw a dip in their gambling budget.

Macquarie is not really surprised. The report serves to confirm what the broker suspected all along judging from the feedback from gaming companies. 

Macquarie analysts highlight the pandemic has accelerated Tabcorp Holdings' ((TAH)) structural challenges within its wagering business given the ongoing digital mix-shift and broker prefers to be cautious on the stock for now.

For casinos, the broker does not foresee any structural impact and expects improvements in casino revenue trends as restrictions ease.

Star Entertainment Group ((SGR)) continues to be Macquarie’s top pick within the Australian gaming segment.

Budget Breaks: More of a morale booster

Two of the federal budget's temporary policies aimed at reviving flailing businesses – a scheme for full expensing of eligible capex and a scheme for temporary loss carry-back – fails to impress UBS analysts who believe the direct impact on companies will be rather muted.

Temporary capex expensing is being looked at as a “game changer” but UBS analysts do not share the enthusiasm. The scheme may be beneficial for boosting the cash flow of the businesses it will not really make a difference to a company’s earnings as such.

The scheme allows companies with a turnover of up to $5bn to deduct the full cost of certain eligible capital assets. These assets must be bought on or after October 6, 2020 and must be first used before June 30, 2022.

UBS analysts point out while capex expensing may lower the tax paid now, it also creates a deferred tax liability.

One way this policy could directly impact earnings, suggests UBS, is if the company uses the cash flow boost to reduce its debt or buy back shares. Another way is if the better cash flow were to lead to higher dividend payout ratios, or be used for investing more in business or pay wages.

Companies expected to benefit from temporary capex expensing include Seven Group Holdings ((SVW)), Bapcor ((BAP)), Autosports Group ((ASG)), JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)).   

Analysing the loss carry-back tax scheme, UBS finds this, too, won’t have much of a bearing on the earnings growth of companies.

A quick recap – the scheme allows corporate entities with a turnover of less than $5bn to offset their losses that have been incurred up to June 2022 against profits earned since FY19. These offsets cannot be more than the tax paid earlier by the company and will also be limited by the company's franking account balance.

The idea is to target companies that were doing well before the pandemic hit them.

UBS believes while this may be good for the cash flow of these entities, there won’t be any direct impact on the earnings.

Elaborating on this, the analysts explain had the scheme not been introduced, these loss making companies would essentially have created a deferred tax asset.

With the introduction of the scheme, all that will be happening is the companies will be switching the deferred tax asset for cash. Of course, add the analysts, cash is an interest generating asset and could give a small indirect boost to earnings.

This isn’t to say the policies won’t have something positive coming out of them, UBS suggests, as these schemes will give companies some confidence and additional cash flow.

But the broker also warns that probably won’t be enough to stop the business environment from contracting, expected to be -8% in 2020, improving to -3% in 2021.

Some companies expected to benefit from the loss carry-back scheme include Flight Centre Travel Group ((FLT)), Qantas Airways ((QAN)) and Webjet ((WEB)).

Throwing good money after bad businesses

It looks like some of the infamous zombie businesses are finally coming to terms with the fact staying in business might not really be feasible.

According to the latest numbers from CreditorWatch, a digital credit reporting bureau, Australia is seeing "signs of stabilisation" in the business sector. The number of businesses entering into administration rose by 11% in September. This is the first time it has risen since June.

There’s more. The number of business defaults increased by 23% in September, the first since May this year.

What this indicates, explains the CreditorWatch report, is some of the zombie businesses – so called because they eat into valuable resources and do not have a viable future without government stimulus – are realising continuing with the business may not be such a great idea.

In April, data from CreditorWatch noted the number of businesses going into administration lagged last year by -30% in April/May. What that suggested was some businesses should have collapsed and did not.

This hampers the economy as it stops the government from focusing on businesses that are viable and will survive and consequently help more people.

Overall though, CreditorWatch admits defaults and administrations have shown a long term decline.

Looking at data for September 2020, the report adds there are considerable differences between states, with Victoria noting a 23.8% increase in business administration after a -49.3% decrease in August. Queensland recorded a drop of -25.4% in administrations in August, increasing to 24.1% in September. NSW, on the other hand, noted another decline in administrations at -1.6%, albeit better than August’s 34.4% reduction.

Wow

Morgan Stanley analysts prefer Woolworths ((WOW)) over Coles ((COL)) as their preferred major supermarket exposure.

Australian supermarket stocks are Morgan Stanley's preferred retail sub-sector exposure. The analysts believe the supermarkets are well placed over the medium term especially looking at covid related tailwinds, improving food inflation trends and a sector that offers attractive value in a low yield world.

While Coles had been the broker's pick since April, helped by a better yield and defensiveness, Morgan Stanley’s preference has shifted to Woolies now.

Woolworths’ share price has underperformed Coles’s by about -22% since February. The retailer's operational momentum has also improved with Morgan Stanley experts pointing out Woolies started the year with better food momentum. Not only that but it looks like Woolworths has taken the lead in liquor as well as online.

The retailer’s hotels business makes Morgan Stanley believe the major supermarket is also better leveraged to a post-covid recovery.

Morgan Stanley has lifted Woolworths’ rating to Overweight. Coles remains intact at Overweight but the broker prefers the former.

Another stock Morgan Stanley like is Metcash ((MTS)), aided in no small measure by covid-induced local shopping which has seen the company taking share in food and liquor. However, it is the hardware business that remains the key growth driver, emphasises Morgan Stanley.

Metcash is trading at a circa -50% discount to the ASX200 industrials (ex financials) versus its average -35% since 2010. Morgan Stanley analysts think the stock is far too cheap implying there is considerable scope for a share price rise.

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