In Brief: Consumer Spending, NZ Blueprint, Less Covid Testing

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Weekly broker wrap: Spending to persist, neighbouring economy pre-empts Australia, covid testing declines, general insurers expect rate-driven return increases.

-Strong second quarter suggests consumer spending to persist in third quarter, before fourth quarter decline
-New Zealand economy provides read-through for Australia’s outlook, and impacts of inflation
-Covid volumes, and testing reimbursement, decline as normalisation continues
-Rate hikes look to drive income tax return increases over the coming two years

By Danielle Austin

Second half growth drives analysts to delay inevitable consumer spending decline

Growth in Australia’s gross domestic product in the second quarter has seen Jarden adjust its economic outlook, accounting for a two-to-three-month lag in rate hikes impacting household spending. The broker is anticipating stronger consumer spending to persist into the September quarter, before a large moderation in the December quarter.

The stronger than expected second quarter was underpinned by a rebound in services, including a 30% quarter-on-quarter rise in tourism spend. Despite this, Jarden’ expects rate hikes, and resulting increases in mortgage payments, will drag on disposable income.

Jarden is also predicting savings rates to decline below pre-covid levels before the end of 2022. The broker continues to forecast consumption growth, of 12% and 4% in 2022 and 2023 respectively, but notes this will largely be driven by price rather than volume increases.

With middle income families most exposed to the impact of rising rates, Jarden suggests retailers with higher exposure to this demographic are most at risk. Favouring retailers with high income exposure and younger demographics, Jarden has a preference for Treasury Wine Estates ((TWE)), Premier Investments ((PMV)), Lovisa Holdings ((LOV)), Universal Store Holdings ((UNI)) and Accent Group ((AX1)).

The broker believes Harvey Norman Holdings ((HVN)), JB Hi-Fi ((JBH)) and Super Retail Group ((SUL)) may face headwinds. The market also anticipates consumers will be increasingly value-focused, likely benefitting supermarkets, with Jarden retaining its preference for Woolworths Group ((WOW)), as well as fast food providers like Collins Goods ((CKF)) and Domino’s Pizza ((DMP)).

Through the looking glass of New Zealand’s rate hike cycle

Analysts are treating New Zealand’s rate hike cycle, and its emerging impacts, as a read-through for Australia’s own economic outlook. With both countries entering a rate hike cycle with similar backdrops of strong business, solid household, banking and government balance sheets, and a strong labour market, our neighbours could hold up a mirror to Australia’s not-to-distant future.

Rate lifting was enacted in New Zealand a full seven months earlier than Australia, in October 2021, and rates have now increased 275 basis points over seven hikes. Given this early action, impacts are now starting to emerge across the economy, notably with a house price decline of -9% from a peak in November 2021.

In addition, employment growth has been largely flat over the last six months, and the retail industry reported a -2.3% sales decline in the second quarter. Consumer confidence dived early in the year, and remains at record lows, and Wilsons believes there is risk that the New Zealand economy could slow more sharply than expected. Analysts are anticipating a further slowing of momentum in the remainder of the year, with Wilsons noting the market is pricing in a further 90 basis points in hikes.

By comparison, Wilsons notes the market has priced in a similar 85 basis points in hikes from the RBA through to the end of 2022. Despite a number of rate hikes from the RBA, Australia’s gross domestic product grew 3.6% year-on-year in the June quarter. Analysts are now interested in whether the RBNZ will continue to enact rate hikes as effects start to emerge across housing, consumer spending and labour markets.

Testing reimbursements lessened as volumes decline

In further signs the world continues to normalise post-covid, testing volumes continued to decline in recent months. Domestic pathology businesses which benefitted from elevated testing in recent years will likely look to rely more heavily on base businesses as earnings revert.

Alongside this decline, Medicare has announced a reduction in reimbursements available to private providers offering covid PCR tests. Reimbursements will decrease -19% from October 1, to $68.85 from a current $85.00, and Credit Suisse analysts expect this will reduce further to $50.00 in 2023.

Domestic testing volumes took a sharp decline in August and September, with a current average of 38,000 tests per day the lowest testing rate since pre-Delta. This compares with 60,000 per day in August and 75,000 per day in July, and Credit Suisse has conservatively assumed an average 43,000 test per day in the coming half.

Accounting for these changes, Credit Suisse cut earnings per share forecasts for companies within its  pathology coverage. Forecasts decline -19%, -6% and -1% for Australian Clinical Labs ((ACL)), Healius ((HLS)) and Sonic Healthcare ((SHL)).

Domestic general insurers to benefit amid rate hikes

Investors waiting for domestic insurers to gain the full benefits of rate hikes won’t be waiting much longer according to Jarden, with the broker taking a positive view of the industry’s outlook post FY22. The broker notes rate rises look to accelerate across personal lines to the highest level in a decade, and should drive underlying insurance trading ratios into target ranges by FY24.

In the two years to FY24 Jarden predicts insurance trading ratio profits to lift 23% and 45% for Insurance Australia Group ((IAG)) and Suncorp Group ((SUN)) respectively. The broker estimates IAG’s insurance trading ratio margins lagged Suncorp’s in the last year, having adjusted for the former’s reinsurance quota share benefit.

Jarden assumes IAG can achieve a 16% insurance trading ratio by FY24, and Suncorp Group will reach a 10-12% ratio.

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