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The Wrap: Lockdowns, Pathology & Automotive

Weekly Reports | Jul 02 2021

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Weekly Broker Wrap: lockdowns and covid-19; pathology; Australian dollar; and motor dealers

-Sydney lockdown unlikely to reduce the magnitude of consumer expenditure
-Whether the UK re-opened prematurely hinges on hospitalisations/deaths
-Support for pathology stocks from the pandemic likely to continue through 2021
-Australian dollar rally sensitive to more hawkish commentary from central banks
-Motor vehicle supply shortages unlikely to be resolved quickly

 

By Eva Brocklehurst

Covid-19 & Oz Lockdowns

Lockdowns are obviously needed, JPMorgan suggests, and more so if the spread of the virus persists, yet so far the broker does not believe there is sufficient reason to shift short-term GDP forecasts on the back of the Melbourne lockdown in May and the current one in Sydney.

JPMorgan has long expected the withdrawal of government support would mean GDP growth will drop a few notches, yet notes there are limits on how much expenditure should slow given the elevated savings rate. At this stage there is not enough information to show that these lockdowns will reduce the magnitude of expenditure, rather it is likely to be just redistributed.

NSW represents around one third of Australia's economic activity, Morgan Stanley notes, of which greater Sydney takes up three quarters. The direct economic impact of this lockdown is estimated to be around -$2bn, or -0.1% of annual GDP for the state.

While the broker notes there have been limited impacts on other states in prior lockdowns, and the areas under restriction has bounced back relatively rapidly, there are several differences this time.

The cluster in Sydney involves the more infectious delta variant which increases the chance that cases have spread to other states, and highlights the difficulty of returning to a zero covid environment.

There is also less support from the federal government, although it has introduced a one-off payment to individuals affected by an extended lockdown and NSW is likely to introduce a business support measures. This is still smaller than the suite of measures previously available.

Mobility, which JPMorgan assesses is the most immediately measurable effect of restrictions on activity, is a less useful guide to economic outcomes. Some spending segments which did particularly well during initial lockdowns in 2020, such as hardware and electronics retailing, sustained their performances for a little longer after mobility was restored.

The broker believes the reason was the accompanying government income support was not spent immediately. As the savings rate remains high there is probably some capacity for more expenditure in this regard.

Economic variables that move positively with mobility, such as restaurant bookings, tend to do so for fundamental reasons involving personal consumption and have a more stable relationship with mobility. At this point household preferences for expenditure appear to matter just as much as mobility, the broker concludes.

Meanwhile, vaccine take-up in Australia is low with around 25% of the population receiving at least one dose and only 5% two doses. As a result, Morgan Stanley suggests hedging is prudent for portfolio positioning and has added a quality tilt to its value bias.

Covid-19 Globally

Globally, JPMorgan notes localised European lockdowns this year have not delivered the equivalent damage to GDP caused by the 2020 shock. Oxford Economics points out new global cases of coronavirus have fallen below the March lows and rapid vaccination programs have allowed economies to re-open.

Nevertheless, despite leading the way in vaccinations within the G20, the UK has experienced a sharp rise in cases and now has the third highest number of cases per million in the G20. Still, hospitalisations are low so recent developments are not an automatic alarm bell.

Whether UK made a mistake re-opening prematurely will hinge on what happens to hospitalisation and deaths, the analysts suggest. But the rise in cases does highlight the risk of variants that trigger further surges in coronavirus in those economies that are made limited progress with vaccines.

Oxford Economics makes two points. Although the combination of vaccine and restrictions on mobility can keep the number of cases low, reducing these to very low levels is easier said than done.

Secondly, high vaccination rates are not a guarantee of a smooth path to normality. Israel is a case in point where its vaccination program has been a game-changer but in response to a sharp increase in case numbers the country has been forced to reimpose the use of masks in public indoor areas.

Pathology

Jarden finds forecasts for FY21 for the pathology stocks Sonic Healthcare ((SHL)), Healius ((HLS)) and Integral Diagnostics ((IDX)) are complicated by the stop/start nature of lockdowns across Australian states.

The broker anticipated reimbursement pressure would emerge but this is now unlikely to occur during the remainder of 2021. State governments continue to encourage Australians to roll up for testing.

As there is so much emphasis on testing, Jarden believes it unlikely the federal government will attempt to reduce reimbursement and disrupt the initiative, at least until 2022, when it should coincide with significantly reduced infections as vaccination rates penetrate the population.

Hence, Sonic Healthcare and Healius are clear beneficiaries of the volume. Monthly Medicare pathology and diagnostic imaging volumes have also consistently beaten the broker's forecasts since initiating on these stocks in April.

Medicare data alone has resulted in revenue upgrades for all three. The broker points out Integral Diagnostics is more exposed to Victoria than the other two for diagnostic imaging as a proportion of the group total so the potential impact from that state could dampen the growth that has been experienced in the second half of FY21.

On the other hand, Integral Diagnostics has no exposure to NSW and so the lockdowns in greater Sydney should be of little consequence to volumes.

Australian Dollar

The Australian dollar rallied strongly over the past 6-12 months but then rapidly lost several cents to be just under US$0.75. The main reason Wilsons observes for the softening currency was surprise commentary from the US Federal Reserve which appeared to be less dovish on inflation and the likely timing of rate increases.

The Fed's guidance suggests the timing of rate hikes has moved to 2023 from 2024. In response, the US dollar rose against most currencies as did the short end of the yield curve. In turn, cyclical sectors and commodity-sensitive currencies such as the Australian dollar fell.

Still, Wilsons notes markets have stabilised as the Fed remains accommodative and expects the early July meeting from the Reserve Bank of Australia will provide more guidance around how it views the policy cycle.

A modestly hawkish surprise cannot be ruled out, given the shifting views of other central banks as well as stronger-than-expected domestic data. While the US may be firm over the next few months, Wilsons doubts the market is on the verge of a major break to the upside.

The broker continues to expect US dollar weakness from an extended period of above-trend global growth and heavy US bond issuance along with a persistently large current account deficit. Hence, the Australian dollar is likely to participate in the broader appreciation trend against the US currency.

Motor Dealers

Jarden has expanded its automotive coverage to include Eagers Automotive ((APA)) and Autosports Group ((ASG)), with Overweight ratings and targets of $16.21and $3.05 respectively, as these are benefiting from supply shortage of new vehicles relative to a recovery in demand.

Both operate integrated automotive dealership networks. Despite the rebound in 12 month volumes these are still -13% below the peak in March 2018 and Jarden is positive regarding sector sales.

The supply shortages are unlikely to be resolved over the short term as there is been increased demand for chips, and production lead times generally range from 4-6 months, which assumes contracts and production lines are in place as these take time to be installed.

Given the synchronised recovery in demand for new vehicles globally, original equipment manufacturers (OEMs) will need to prioritise production, and with around 80% of vehicles produced for left-hand drive markets there is a risk that supply shortages will remain prolonged in Australia.

There are other earnings drivers the broker envisages, including housing and macro economic strength. Vehicle sales have been strongly correlated with house price growth. There is also the M&A option, as Australia's automotive dealership network is highly fragmented and due for consolidation.

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