The Wrap: APRA Tightening, REITs, Rain, Banks

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Weekly Broker Wrap: Macroprudential measures questioned; Stockland stands out, SME’s are luddites, Ag sector boost, bank headwinds, Qantas, online real estate

-Jarden: Previous macroprudential measures will be ineffective
-Stockland is the standout REIT
-Bumper crops for Ag sector
-Banks shed superior return on equity profile

By Mark Story

Macroprudential tightening: Previous measures won’t work

Having concluded that APRA’s (Australian Prudential Regulation Authority) previous macroprudential measures aimed at cooling surging house prices – including limits on investor and interest only lending – would likely be ineffective in the current environment, Jarden thinks the bank regulator has four options to tighten macroprudential policy.

Firstly, the broker believes APRA could mirror the Reserve Bank of NZ, and place limits on the share of high loan-to-value ratio (LVR) lending, plus limits on the share of high loan-to-income and debt-to-income (DTI) lending.

Two other measures APRA may wish to deploy, adds Jarden, include increasing the loan serviceability buffer from 2.5%, and increasing the counter-cyclical capital buffer (CCyB) from 0%.

While limits on higher LVR lending are arguably the most conventional choice, Jarden believes this would go against the government's own First Home Loan Deposit Scheme which specifically facilitates higher LVR lending.

As a result, the broker thinks the most likely option would be a limit on very high (greater than 6x) DTI lending, potentially limiting them to 20% of new loans.

But if APRA was less concerned about the proliferation of specific higher risk lending, yet wanted to simply moderate house price/lending growth, it could instead, adds Jarden, implement a modest increase in the countercyclical capital buffer.

Jarden notes APRA has previously flagged the likelihood of a non-zero default level in the future for the CCyB to bolster the resilience of the banking sector during periods of heightened systemic risk.

There are five tell-tale indicators Jarden suggests watching to track high risk lending, and the risk of macroprudential tightening.

The first of these is investor credit growth – currently 0.1% year-on-year (YoY), and well below the prior 10% YoY cap. Then there are Interest only (IO) loans which have increased to 20%, but remain below the 30% cap.

After declining from 2012, the share of higher LVRs (greater than 80%) has increased since 2018, with the share of very high LVRs (great than 90%) increasing by 2% since end-2019.

Similarly, while share of very high loan-to-Income (LTI) lending (greater than 6x) has increased from 5% to 7% in two years, it remains below the 10% share prior to 2017.

While the share of very high (greater than 6x) DTI lending has increased from 15% to 17%, Jarden think APRA would likely become concerned if this approached 20%.

Despite the modest rise in higher risk lending, Jarden still regards macroprudential tightening as unlikely till late-2021 at the earliest.

But were APRA to implement effective macroprudential tightening, the broker thinks it would likely see growth in both loans and house prices moderate and be a marginal negative for housing-exposed sectors; in particular banks, consumer discretionary, residential developers and building materials.      

Retail property: Stockland looks best placed to recover

Having analysed the local economy for each postcode within which retail REITs (under its coverage) operate, Morgan Stanley believes it has a rough feel for how each shopping centre is positioned for recovery post JobKeeper cessation.

Originally, all qualifying businesses were paid $1,500 per fortnight per eligible employee, reducing to $1,200 per fortnight from 28 Sept 2020. For the period January 2021 to 28 March 2021, the rate dropped to $1,000 per fortnight per employee (assuming 20hrs+ work per week).

While Morgan Stanley admits its analysis isn't perfect, the broker’s work simply indicates how businesses located in the same postcodes as the 150 shopping centres under coverage are performing, relative to the qualification for JobKeeper handouts.

With JobKeeper handouts due to be wound up at the end of this week, the broker asserts that the best retail portfolio may be the one with assets located in areas where JobKeeper applications have declined the most. What this could signal is that local businesses in the region have generally improved to the point where turnover has trended towards pre-Covid levels.

Based on Morgan Stanley’s analysis, Stockland ((SGP)) looks the best placed retail REIT relative to peers, for recovery once JobKeeper ends completely .The broker’s work also supports the perception that Vicinity Centres' ((VCX)) Melbourne bias means its portfolio is the worst positioned to recover.

The number of merchants seeking handouts in the postcodes where Stockland has shopping malls dropped by around -52% over nine months to December 2020. By comparison, JobKeeper applications only fell -15% across Vicinity Centres Victorian postcodes, over the same nine month period.

Morgan Stanley suspects considerably lower JobKeeper fallout experienced by Vicinity Centres' Victorian postcodes reflects the impact the extended lockdowns have had on businesses, with Victoria comprising around 45% of Vicinity Centres' portfolio.

SMEs: Lost in the 50s

CPA Australia’s recently published Asia-Pacific Small Business Survey reveals Australian small businesses (SMEs) as less likely to invest in, use, earn from or offer customers the use of digital technologies than their Asia-Pacific counterparts.

After surveying 4,227 businesses across 11 markets, CPA data identified Australia’s SMEs as least likely to: Begin or increase online sales during COVID-19; use social media for business; invest in technology in 2020; profit from their investment in technology, and review cyber-security in past six months.

Australian SMEs were also the second least likely to earn revenue from online sales and third least likely to offer customers the choice of digital payment technologies.

While Australian SMEs recorded the lowest result (8.3%) when it came to adding employees, slightly over a fifth, (22.3%) grew their businesses last year – the second lowest result of any market surveyed.

Despite the impact of covid, 36.1% of Australian small businesses reported making no "major change" in response to the pandemic, the highest result of any market surveyed. Nor did they access government support, negotiate rent reductions or loan holidays, delay taxation payments or reduce capital expenditure.

Australian SMEs expect to fare better in 2021, however, they may still underperform other Asia-Pacific businesses. For example, only 41.4% of Australian SMEs expect to grow this year compared with the survey average of 60.8%. Meantime, 13% expect to increase employees numbers, compared with the survey average of 35%.

Only 6.7% of Australian small businesses stated they will introduce a product, process or service that is unique to their market or the world in 2021, compared with 23% in other markets.

Extreme rainfall: Bumper crop production predicted

Improved soil moisture content levels for the inland farming regions, notably in NSW, Queensland and Victoria following recent rainfall, after being significantly impacted by drought over the past three years, is expected to underpin a solid agriculture recovery. Equally encouraging, significant rainfall has been observed across the coastal regions of NSW over the past week.

As a result, agriculture industry body ABARES is forecasting a 27% increase in planted hectares in Australia in FY21. Improved agriculture conditions have also coincided with a significant increase in key soft commodity prices, which together have driven a rapid improvement in farmer economics and sentiment.

UBS highlights wheat prices, which make up around 60% of Australian crop production, are up circa 50% versus last year.

Underpinned by the strengthening outlook for international fertiliser prices (DAP and Ammonia), plus improving conditions for the company’s domestic fertiliser distribution business, UBS has a Buy-rating on Incitec Pivot ((IPL)) and a target price of $2.85.

The broker is forecasting Incitec Pivot to deliver FY21 earnings (EBITDA) of $70m, up 111% versus the weather-affected previous period. However, UBS notes key risks, which include shifts in global commodity prices, the ability to source economic gas feedstock, foreign exchange volatility, mining sector customer concentration risk, adverse weather patterns impacting mining/agricultural activity, and changes to ammonium nitrate market supply/demand balances.

UBS also has a Buy-rating on Nufarm ((NUF)) – target price of $5.70 – where recovering agriculture conditions, reversal of cyclical input cost pressures and the re-basing of the group's cost base are driving a significant earnings recovery. UBS has factored in Nufarm's exposure to volatile agriculture markets with the broker’s use of an elevated cost of equity at 10% versus 7% market cost of equity.

Risks highlighted by UBS include a potential glyphosate litigation, adverse weather across key regions of North America, Europe and Australia, foreign exchange volatility, shifts in global soft commodity prices, and general global economic downturn risks.

Australian banks: Margin headwinds

Having hit a sweet spot in 2021, the Big Four banks are expected to benefit from lower funding costs of between -16 and -22bps. However, Macquarie expects margins to be broadly flat (-2bps to 2bps) in 1H21 and resume their modest decline in later periods.

Macquarie attributes pressure on margins to headwinds and pressures on the lending side as banks compete more aggressively for new business.

While stretched valuations and longer-term headwinds make it difficult to be bullish, Macquarie recognises the relative appeal of banks in the current environment. However, the broker suspects well-known headwinds, namely, impact of lower rates and impact of asset price competition have been underestimated by the consensus expectations.

The broker believes the 42% premium Australian banks are trading at versus global banks (18%) is no longer justifiable given a superior return on equity (ROE) profile has largely disappeared. Macquarie retains a Neutral sector view but has switched preference for the regionals over the majors, due to greater leveraged to improving deposit pricing.

Macquarie has upgraded its recommendation on Bendigo & Adelaide Bank ((BEN)) to Outperform, which along with ANZ Bank ((ANZ)) are the broker’s two preferred exposures. Underpinned by higher operating leverage, the broker believes ANZ continues to offer more upside than peers on a relative basis.

Following recent underperformance, Commonwealth Bank ((CBA)) has been upgraded to Neutral from Underperform, while Macquarie has downgraded Westpac ((WBC)) to Neutral from Outperform following its re-rating. Macquarie retains a Neutral recommendation on National Australia Bank ((NAB)) which appears fully valued at current levels.

Macquarie has upgrade earnings across the Big Four by around 1-2%, while upgrades for the regionals are more significant, up to 17%.

Due to the differences in banks’ starting points, the broker expects headline margin benefits are more significant for CommBank and Westpac, while the impact on earnings is biggest for Westpac, followed by ANZ and NAB, with CommBank deriving the smallest uplift.

The broker remains restricted on Bank of Queensland ((BOQ)), with earnings changes driven by incorporating the completed equity raising, the acquisition of ME Bank, and management-disclosed synergies.

Macquarie forecasting earnings per share (EPS) changes of -11%, 13%, and 17% in FY21, FY22, and FY23 respectively. The broker also expects all banks to lift their dividends in FY21 and FY22, and is forecasting dividend yields of around 4-5%.

Airlines: Qantas leveraged to aviation recovery

Based on The Bureau of Infrastructure, Transport and Regional Economics' (BITRE) domestic airfare data for March 2021, the ‘best discount” fares declined by -23% year-on-year (yoy), while ‘Restricted Economy’ declined by -18% yoy.

Goldman Sachs highlights volatility of fares as a key characteristic over the past six months, with airlines continually adjusting fares to fill scheduled capacity amid uncertainty around state borders remaining open. This uncertainty saw consumers defer travel and the ‘cheapest available’ airfare prices declined -13.8% yoy with declines experienced across most routes.

However, through the past six months airlines have been relatively proactive in restricting capacity to accommodate lower demand for travel, and reducing discounts on airfares to manage profitability. On a full year to date basis, prices remain up 1.9% yoy.

Goldman Sachs notes increases on the Canberra-Melbourne (up 63% yoy); Melbourne-Perth (up 54% yoy) and Perth-Sydney (up 41% yoy) routes, which the broker believes highlights the inelasticity of government and resource sector led demand.

As border restrictions are relaxed and as airlines increase scheduled capacity ahead of the April holiday period, Goldman Sachs sees growing need for the carriers to increase discounting to incentivise travel (in particular leisure).

Based on its leveraged exposure to the aviation recovery trade, the broker reiterates a Buy rating on Qantas ((QAN)) with a 12-month target price of $6.38. While average ticket prices are falling, Macquarie notes that a greater proportion of this travel is being taken on leisure routes and for Qantas, expects greater penetration of the low-cost Jetstar brand.

Goldman Sachs regards Qantas a strong recovery investment with Qantas/Jetstar brands forecasting capacity to return to around 80%-100% of pre-covid levels during the upcoming April holiday period.

Online real estate portals: REA to outperform Domain

Having reviewed its investment theses for the two listed online real estate portals, REA Group ((REA)) and Domain Holdings Australia ((DHG)), Macquarie has upgraded the former to Outperform from Neutral, while the latter has been downgraded to Neutral from Outperform.

Underpinning Macquarie’s investment thesis on REA is a mix-shift opportunity into the medium term; higher quality business with greater audience/network effect; and valuation spread between REA and Domain which is at an historical low. The broker believes REA has greater pricing power given its market leading position, and notes that its 115 million monthly visits to its website and apps represent around 3.3 times that of Domain.

To reflect higher mix-shift, Macquarie is forecasting REA to deliver earnings per share (EPS) growth in FY21, FY22, and FY23 of 2.6%, 6.7%, and 10.9% respectively, and has lifted its price target 8.7% to $171.70 from $158.00.

Despite strong revenue and earnings (EBITDA) growth from the residential cycle, what underpins the broker’s downgrade for Domain is relatively softer yield growth.

While Domain has been successful at closing the listings inventory gap with REA over the last few years, Macquarie notes that the audience differential remains material with 7.1 million unique digital audience as at November 2020 (compared with REA’s 12.3m).

To reflect slightly softer mix shift growth, Macquarie is forecasting Domain to deliver EPS growth for FY21, FY22, and FY23 of -4.4%, -4.9%, and -4.6% respectively, and has cut the target price by -26% to $4.33 from $5.81.

After surveying around 1,000 agents nationally to understand key motivations behind using each platform, Macquarie found that while 78% of agents use both platforms, 81% indicated they would use REA if they had a choice of only one platform.

The broker believes REA can lift prices higher due to a larger audience and incentive to capture a larger share of marketing budgets. While REA has a unique audience of 12.3m, 1.7x that of Domain’s 7.1m, Macquarie notes similar trends for other ratios such as time on site, app downloads, app openings, and site visits (2.5x in last six months).

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