In Brief: Banks, Construction And Fertilisers

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Weekly Broker Wrap, In Brief: Bank margins improve on rate rises; construction sector suffering continues; gas price hike benefits local fertiliser industry; growth outlook for supermarkets.  

-Bank margins set to be big winners of RBA cash rate rises
-Downtrodden construction sector faces further intensification of cost pressures
-European gas prices drive fertiliser price increase as costs are passed on
-Reversal of pandemic costs coupled with inflationary environment could equate to growth for supermarkets 

By Danielle Austin

Majors to benefit from cash rate hikes

Market consensus is that impending RBA cash rate rises will be a positive for the banking sector, and particularly the majors, anticipated to drive margin improvement.

Historically, return rates on assets will follow rate hikes while liabilities are slower to increase and analysts at Goldman Sachs anticipate the competitive position of majors will improve with cash rate hikes as those banks become the marginal lenders, while wholesale peers lose ground.

Based on the assertion that cash rates domestically are likely to rise to 2.5% by year end 2024, the broker estimates a nearly 0.3% rise to net interest margins of major banks, but further upside potential exists from price competition. To justify current margins assumptions, the broker explains variable mortgage rates would increase by 1.5%, and Goldman Sachs explains the upside comes from this fairly conservative increase. 

The broker noted particular value in National Bank ((NAB)) given the bank’s proven management of the volume-margin trade off, but also notes both Commonwealth Bank ((CBA)) and Westpac Bank ((WBA)) will offer more interest margin leverage to higher rates. 

Construction sector insolvency on the rise

Construction companies could be on the chopping block according to Jarden, as a slew of insolvencies in the industry amid a challenging sector environment looks likely to be just the beginning.

Leniency from the banking sector and Taxation Office has driven insolvency levels to near-record lows, but industry insiders are predicting a gradual rise in enforcement activity later in the year to achieve normalisation in 2024.

The sector has struggled as supply and labour constraints push up costs in a high demand environment, with these impacts likely to intensify moving forward given current geopolitical and weather events.

Surging construction costs, up 20-30% from 2020, have been the key driver of construction company failure, and the current Russia-Ukraine conflict and domestic flood events only look likely to drive costs higher.

The cost of labour has also been a challenge for the sector, also only set to intensify as the labour market tightens looking down the barrel of an 18-24 month pipeline of work opportunities on the other side of flood events. 

The broker notes banks are largely insured against industry failures, but developers face the likelihood of 20-30% increases to project costs. 

European energy crisis drives local fertiliser boom

In a flow on effect, exposure to rising European gas prices is driving elevated ammonia and ammonia nitrate prices which in turn look set to lift fertiliser prices globally.

Morgan Stanley is predicting ammonia prices to remain above US$1,000 per tonne through the remainder of the year, with Title Transfer Facility gas futures rising more than 60% in the last month and suggesting further potential elevation to spot pricing. 

For local producers like Incitec Pivot ((IPL)) and Orica ((ORI)), the current pricing environment should offer benefits, point out Morgan Stanley. The broker predicts more immediate benefits for Incitec Pivot given the company’s access to a lower-priced gas supply at WALA. With WALA gas prices increasing a comparatively low 20% in the last month, Incitec Pivot should be able to circumvent high ammonia pricing. 

For Orica, however, Morgan Stanley expects benefits will be longer-term. With a subset of APA Group ((APA)) contracts up for renewal this year, Morgan Stanley analysts expect the company will be able to leverage high spot pricing. The broker forecasts pricing growth of $50 per tonne in both FY23 and FY24, up from the previously forecast $30 per tonne growth. 

Post-pandemic growth in groceries 

With covid-related expenses anticipated to ease in the coming year, Jarden considers the grocery market in Australia well placed for a period of growth ahead and likely to outperform market expectations. Taking cues from international peers, the broker’s sector outlook is underpinned by cost improvement, an inflationary environment, and structural margin improvements.

While covid costs equated to between 0.3-0.9% of sales for supermarkets in the first half, Jarden analysts expect this trend to somewhat normalise into the next financial year.

At the top end of the range sat Woolworths ((WOW)), reporting costs equating to 0.9% of sales and a year-on-year cost of doing business increase of 9%, while Coles ((COL)) was close behind, with costs equating to 0.8% of sales and a year-on-year cost of doing business increase of 4%.

Jarden posited that while Coles has better controlled costs to date, Woolworths has more opportunity to improve performance through new revenue channels. 

Expected inflation in coming months should further benefit the grocery sector, with Jarden anticipating a more than 4% year-on-year hike in dry goods, and a more than 20% price hike in some large fresh produce categories.

While the broker does not expect margins to recover to peaks, it does see potential for margins to structurally improve post-pandemic. Supermarkets are operating more efficiently, and the reversal of covid, labour and supply chain related costs should drive margin improvement. The broker currently estimates a market consensus on industry growth of 2.75-3.50%, but expects supermarkets may exceed this.

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