The Wrap: Vaccine & Consumption, Commodities

Weekly Reports | Nov 13 2020

Impact of a vaccine on consumption patterns; strata premiums expected to keep growing; with Europe and the US distracted, it is up to China to drive the demand for commodities.

-How will a vaccine impact consumption? 
-A look at the skewed strata insurance industry
-Demand (ex-China) for metals expected to rise in 2021

By Angelique Thakur

Post-vaccine consumption trends

The latest positive development related to Pfizer’s vaccine’s trial makes one wonder what implications such a vaccine may have on Australian retail and discretionary consumption. The onset of the virus saw Australian spending patterns changing significantly with food delivery, home improvement and office furniture seeing a huge uplift in sales.  

Will a vaccine disrupt consumption patterns again? 

Yes, according to Morgans, who goes so far as to say a vaccine, if developed, presents “the largest threat to the consumer discretionary sector”. While Macquarie isn't quite so fearful, the broker does expect to see a moderation in spending on consumer durables. 

The good news is both Macquarie and Morgans think any step-change would take place in 2021 with the Christmas season expected to be a "boomer".

One might think supermarkets, one of the biggest beneficiaries of the fallout from the pandemic, may be in for a tepid growth outlook. Citi begs to differ. Vaccine or no vaccine, states a firm Citi, supermarkets remain well placed and quite immune  to any developments on the vaccine front.

One of the reasons for Citi's optimistic stance is the expected decline in covid-related costs with the development of a vaccine. With the situation improving and companies becoming more adept at managing things, covid-related costs have fallen by circa -40% in the FY21 September quarter versus the FY20 June quarter.

According to Citi, covid-related fixed costs form about 0.4% of sales, expected to reduce to zero should a vaccine become available.

Online sales growth witnessed by the supermarkets is another reason for Citi’s optimism. Online sales are expected to increase to 7.3% for Coles ((COL)). This increase is even more pronounced for Woolworths ((WOW)) at 8.6%. Macquarie considers Woolworths best placed to take advantage of this new behavioral shift towards online shopping.

Going ahead, online sales, while somewhat margin dilutive, will be an important driver of market share, asserts Citi.

Lastly, Citi does not expect working from home to end anytime soon, in turn pushing supermarket spending. In Western Australia, the work from home trend has led to the supermarkets witnessing a double-digit growth of 13% with café and takeaway food growing at 10% during the September quarter.

Citi retains its Buy ratings on Woolworths and Coles while Macquarie prefers Woolworths over Coles. Macquarie is not so positive about Domino's Pizza Enterprises ((DMP)). While a clear winner of the pandemic, Macquarie thinks going ahead, the covid-led pizza orders will begin to normalise.

Expecting a more conservative same-store sales growth profile, Macquarie downgrades its rating on Domino’s to Underperform.

What about consumer durables?

Consumer durables have also benefited from social restrictions with consumers spending more on home appliances in lieu of holidays etc. Macquarie feels this trend will see a reversal as people start socialising again.

That and the reversal in the "shop local" trend sees Macquarie downgrading Metcash ((MTS)) to Neutral. Citi continues to maintain its Buy rating on Metcash.

Macquarie prefers Harvey Norman Holdings ((HVN)) in the discretionary retail category because of the retailer’s exposure to regional Australia which is expected to benefit from improved rainfall and lead to higher spending on home appliances. Wesfarmers ((WES)) and JB Hi-Fi ((JBH)) have been downgraded to Neutral from Outperform.

Believing the market won’t be so willing to capitalize their earnings anymore, Morgans has lowered its ratings to Hold from Add on Beacon Lighting Group ((BLX)), Accent Group ((AX1)), Baby Bunting Group ((BBN)), MotorCycle Holdings ((MTO)) and Super Retail Group ((SUL)).

Some stocks Morgans thinks are most leveraged to a return to normality include Lovisa Holdings ((LOV)), Apollo Tourism & Leisure ((ATL)) and IDP Education ((IEL)).

Eagers Automotive ((APE)) is less vulnerable to macro-economic factors due to its cost out strategy and is preferred by Morgans. Other preferred picks include Breville Group ((BRG)) and Collins Foods ((CKF)).

Are we stratisfied?

Gross written premiums (or the total premium given to the insurer less any deductions) for strata insurance have been rising by 8-10% on average over the last three years. But that’s not all. Strata premiums are also expected to keep growing for the next 12-24 months.

A quick look at what strata insurance is. It is mandatory to have insurance covering the common/shared property for building complexes like flats and apartments against loss or damage. This type of cover is strata insurance. Common areas like pools, lifts, parking lots etc are also included. A strata policy of insurance normally covers properties within one building or land block or complex and is available for both residential strata and commercial strata properties.

According to a study by Macquarie, the construction boom in recent years has fueled a growth in strata schemes at the rate of circa 3.8% per annum over the last two years. The market size is now circa $1.1bn, making strata insurance one of the largest products in the country

As mentioned at the beginning, the strata insurance market has also seen gross written premiums rise – quite strongly at that - over the last few years.

A combination of construction growth and premium rate tailwinds have contributed to a circa 8.2% compounded annual growth rate in premiums (GWP) for strata insurance products over the past four years.

But here is the anomaly.

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