The Wrap: Property, Insurance And US Dollar

This story features ABACUS PROPERTY GROUP, and other companies. For more info SHARE ANALYSIS: ABP

Weekly Broker Wrap: Property; insurance; MOD Resources; US debt ceiling & US dollar.

-A-REITs positioned for solid risk-adjusted returns
-Credit Suisse prefers domestic insurers with margin expansion opportunities
-MOD Resources ramping up scale in Botswana
-Modest risk of US government shut-down on any budget hiatus
-Mining commodities lifting, stemming from demand by G3
 

By Eva Brocklehurst

Property

Ord Minnett observes property asset prices strengthened considerably over FY17, pushing up net tangible assets for the sector by 8%. Occupancy increased to 97.5%, a rise of 0.5%. Income growth was a different story, slowing by -50 basis points throughout the year to around 2.5%, as headwinds affected the retail segment.

Heading into FY18, the A-REITs trade at a free cash yield of 5.9%, with sub 30% gearing, and the broker believes they are well-positioned for solid risk-adjusted returns. Active names outperformed retail-focused exposures in FY17.

In summary, going forward, the retail environment is observed to be challenging but cash flow growth is positive, the earnings outlook for office is disappointing and the residential cycle remains elongated, although volumes have peaked.

Ord Minnett saw Abacus Property ((ABP)), Aveo Group ((AOG)) and Charter Hall Group ((CHC)) as outperforming in FY17. Scentre Group ((SCG)), Charter Hall Retail ((CQR)), Vicinity Centres ((VCX)) and Westfield ((WFD)) all underperformed.

Citi finds the outlook for FY18 better than previously expected, with scope for guidance upgrades improving the valuation appeal. The challenging retail outlook remains the drag on the potential outperformance.

Growth is becoming more concentrated, as around 80% of sector growth is driven from 50% of the market capitalisation. In this regard Goodman Group ((GMG)), Stockland ((SGP)), Mirvac ((MGR)) and Scentre Group are the drivers.

The broker suggests the residential outlook is sound for both Mirvac and Stockland but more than just late-cycle tailwinds are required. Citi prefers Stockland over Mirvac. The broker also prefers Goodman Group, Vicinity Centres, Charter Hall and Investa Office ((IOF)).

Insurance

Credit Suisse was concerned during the reporting season that share prices across the insurance sector were getting ahead of reality. However, guidance was generally conservative, with Medibank Private ((MPL)) the exception that talked aggressively about the potential in the outlook.

Margins were little changed and the broker continues to have a preference for domestic general insurance names, that have early-cycle margin expansion opportunities, versus the private health insurance names that appear close to peak margins.

Insurance Australia Group ((IAG)) is a preferred pick and value is seen emerging in Suncorp ((SUN)) and AMP ((AMP)). Despite the decline in QBE Insurance ((QBE)) Credit Suisse is cautious about the global insurance outlook and remains less upbeat regarding Medibank Private on the potential upside from regulation.

MOD Resources

MOD Resources ((MOD)), a copper company with tenements in the Kalahari Belt in Botswana, has ramped up its project development since discovering the T3 deposit in March 2016. Canaccord Genuity believes the scale of the resource is complemented by other favourable attributes, such as metallurgy, a simple mining operation and the jurisdiction.

The region contains significant mineral endowment and exploration methods have enabled copper responses to be detected that were previously suppressed by surface calcrete. With the lack of quality ASX-listed copper developers to capitalise on strong commodity prices, and upside to the base case valuation, the broker initiates coverage with a Speculative Buy and a $0.10 target.

US Debt Ceiling & US Dollar

Commonwealth Bank analysts observe markets are only pricing in a modest risk of a US government shut-down, as crunch time approaches for the US budget and debt ceiling. The analysts expect the government's debt limit to be increased before the US Treasury runs out of money, as failure to lift the debt limit would force a sharp contraction in fiscal policy.

US Congress has not yet passed a budget bill for the FY18 year, which commences on October 1, 2017. Congress is expected to pass a continuing resolution at the last minute, which will be a temporary authority to keep the government open until a more permanent resolution is agreed.

President Trump has threatened to force a shut-down if Congress does not provide money for a border wall between the US and Mexico, while a small group within the Republican Party has indicated it will vote against any bill that does not cut spending.

The analysts suggest a government shut-down is more a potential political disaster than an economic one, as the party that is blamed by the US public for the inconvenience of closing government services risks an electoral backlash. Hence, as the Republican Party controls both houses and the White House, the analysts envisage only a modest risk of a government shut-down.

Meanwhile, the decline in the US dollar is occurring faster than the Commonwealth Bank analysts expected, although the reasons for the depreciation have not changed. The analysts now envisage the euro rising to US$1.28 and the Australian dollar rising to US$0.85 by the end of 2018.

The next move in eurozone interest rates is expected to be up, because of improving economies and moderately rising inflation, which is expected to have a greater appreciating impact on the euro than will the lifting of US interest rates over 2017/18 have on the US dollar.

The analysts bring forward forecasts for euro appreciation against the US dollar because eurozone GDP growth is expected to surpass consensus forecasts and the European Central Bank should soon signal a further tapering of its quantitative easing.

The fiscal inaction by the Trump administration is expected to work against the US dollar, while a strengthening synchronised global economy is typically bullish for commodity currencies such as the Australian dollar.

Mining commodities are lifting, despite increases in supply, and the analysts believe this is because demand by the G3 – US, Europe and Japan – is just as important as Chinese demand for commodities.

The analysts calculate that the conventional measures of Chinese demand for Australian mining commodities overestimate by 12% and other emerging Asian demand overestimate by 19%, while demand for Australian mining commodities by the G3 is underestimated by -10%.

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