Weekly Broker Wrap: Housing, Ratings, Health Care And Utillities

This story features AGL ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: AGL

-New growth drivers in the economy needed
-Little impact seen on AUD from ratings
-Manageable, but negative impact for Oz banks
-Health reforms may be challenged
-Higher power prices support AGL, ORG
 

By Eva Brocklehurst

Wealth Effects

With evidence that rising dwelling prices have played a large role in supporting both employment growth and consumer spending in Australia, Commonwealth Bank analysts argue that, when this wealth effect wanes, there must be a successful handover to other drivers of growth for the economy to prosper.

They maintain a lift in non-mining capital expenditure and public infrastructure, along with taxation reform, are key means to improve the productive capacity of the economy as new drivers of employment must be found.

A succession of interest rate cuts has helped push up dwelling prices because both investor appetite and debt servicing capacity has risen. For the past three years, this dwelling price growth has supported consumer spending in the face of record low wages growth, which the analysts maintain cannot run on indefinitely.

They also maintain that a reduction in official rates to around 0.75-1.00% would probably be the lower boundary in Australia and, as these levels approach, the wealth effect will wane. As the ability of dwelling prices to inflate above and beyond earnings growth has only been made possible by rate cuts and accumulation of debt.

UBS observes home loans have moderated over the last year, with a reduction in investors initially driving the fall. May home lending data suggests signs of stabilisation, which signals to the broker that house price growth will slow over the coming year but will not collapse.

Still, UBS expects the Reserve Bank is likely to cut the cash rate by another 25 basis points in August, given the persistence of low inflation, and this should help to cushion the housing market in the face of record housing supply.

Sovereign Ratings and the Banks

Credit rating agency Standard & Poor's has changed its outlook on Australian government debt to negative from stable. This implies a one in three chance of a downgrade to the AAA rating in the next two years.

The CBA analysts do not believe this change in outlook will trigger a sustained down-leg in the Australian dollar. They emphasise that this is not a cut to the credit rating, merely an increased risk for a reduction. Moreover, even if the Australian government rating were to be cut by one notch in the future this will merely match the rating of many other developed economies.

Credit ratings are not fundamental drivers of the currency, the analysts maintain. Rather, these drivers include commodity prices, current account balances and interest rate differentials. Hence, they do not envisage a reason to change medium-term forecasts and expect the currency to be trading close to US73c by year end.

While a negative outlook was not unexpected from S&P, post the Australian budget, Deutsche Bank was surprised that it was placed on both the local currency rating as well as the foreign currency rating. This is of importance because there is an explicit link in S&P's bank rating framework between the local currency sovereign rating and the bank ratings.

Deutsche Bank estimates that if Australia's major bank ratings were to be downgraded one notch the impact should be manageable, with around a two basis points impact on margins and less than 2% impact on profit, spread over several years as wholesale funding tranches mature.

While the broker does not believe the banks would face capacity issues in funding markets, the potential for a downgrade does represent another downside risk for the banks. This may present an impediment to a valuation re-rating in the short term.

Health Care

As the new parliament takes shape UBS suspects reforms that are not yet implemented and required legislation may be challenged. This would include the cuts to the bulk billing incentive (BBI) and reforms to the aged care funding instrument (ACFI). The broker would expect Senate objections and inquiries to occur where proposed changes and patient costs coincide.

Given the mid year top-up deals done for pathology and diagnostic imaging, UBS believes the impact on relevant stocks is relatively minor.

The broker considers there is a 50/50 probability of changes to Medicare Benefit Schedule indexation. The government wants to extend the freeze to 2020. Despite its importance in the budget outlook, the broker rates an early termination of the freeze as a possibility.

Utilities

Wholesale electricity prices have increased over the last month across the National Electricity Market, up around $10-20 per megawatt hour since mid June. Costs for spot-exposed gas-fired generators have risen due to a major producer curtailing supply in Queensland because of a safety issue.

The problem is unlikely to be resolved soon and it could take several weeks for curtailed supply to be introduced. Sustained higher prices would have a positive impact on earnings for both AGL Energy ((AGL)) and Origin Energy ((ORG)), Ord Minnett maintains.

WiseTech Global

Bell Potter expects WiseTech Global ((WTC)) will report a modest beat on prospectus forecasts when it lodges its FY16 results. The main focus, the broker contends, will be on the outlook for FY17 given the significant uplift in forecasts for this period.

The broker expects the company to reiterate its prospectus forecast at the results and envisages even some prospect of a modest upgrade for FY17. There are no prospectus forecasts for FY18 but Bell Potter forecasts strong double digit growth to continue, assuming some upside from new contracts and/or greater growth from existing contracts.

A Buy rating is retained. Bell Potter raises the target to $5.90 from $5.20.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms