The Wrap: Bushfires & Economy, WA TAB And REITs

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Weekly Broker Wrap: market outlook; Australian economy; housing; property; JeansWest; wealth; gaming; and US census.

-Australian bushfires likely to trigger temporary rise in inflation, impact on GDP
-Modest improvement in housing conditions likely over 2020
-JeansWest warning highlights significant pressures for retail malls
-Increase in adviser churn positive for Netwealth, HUB24
-WA TAB on the market, potential for global competitor to enter Oz
 

By Eva Brocklehurst

Market Outlook

Baillieu predicts equity market returns in 2020 will be modestly positive and international markets should continue with their recent outperformance. The US S&P 500 rallied strongly in 2019 to new record highs and is expected to rally again in 2020, albeit at a slower pace.

A rebound in global growth should drive a robust earnings recovery, the broker assesses, particularly in ex-US international markets. The US presidential election will also be a market driver as will lower geopolitical risks.

Australia's economy is likely to muddle through, meanwhile, and underperform global peers. Baillieu also notes elevated equity valuations in both Australia and the US.

Australian Economy

It remains too early to assess the economic impact of Australia's bushfires, given much of it will be indirect, via lost working days in construction and lower retail expenditure. UBS believes sectors that are most likely to be affected will be agriculture, tourism, retail and construction.

The broker notes the ANZ-Roy Morgan consumer confidence index has already fallen to a four-year low in early January, a negative sign for weak retail sales. Elsewhere, UBS assesses a -10% reduction in tourism for impacted regions.

Citi agrees there will be initial supply shock with a loss of production on the back of damage to businesses, infrastructure and residential properties, which means consumption and investment spending will be initially delayed but will recover as rebuilding gets underway.

Given the indicative cost from the government of the bushfire response is $500m, against an expected budget surplus of $5bn, it appears likely the surplus can be maintained.

The broker expects the crisis will impact on GDP in the fourth quarter of 2019 and first quarter of 2020 by as much as up to -25 percentage points. Moreover, higher headline inflation is likely although much of this will be trimmed out of core measures.

Citi estimates an equivalent reduction in GDP over the two quarters and agrees there will be a temporary impact on inflation. Both brokers expect the Reserve Bank to cut official rates by -25 basis points in February, ahead of downgrading the economic outlook.

Housing

An improvement in housing conditions is expected in 2020, although Morgan Stanley expects price growth will moderate. The broker is confident in a sustained recovery. In particular the turnover of existing housing, which has remained quite low and played a part in amplifying recent price signals.

While a trough in building approvals is also likely, Morgan Stanley suggests this will not offset the construction decline that is expected over the year, although the outlook for 2021 will improve. Moderation in prices is largely driven by credit availability with price growth above 5% difficult to sustain, given the broad shift to an income-based lending system.

While interest-rate reductions can boost serviceability, this has already been reflected in house prices to date. Hence, the broker envisages mid-low single digit increases in national house prices in 2020 while another official rate cut should provide some support.

Property

The main issues for Australian property stocks in the upcoming reporting season are likely to be retail rents and valuations. While finding it hard to pinpoint any bullish potential for owners of retail malls, Morgan Stanley considers Scentre Group ((SCG)) and Vicinity Centres ((VCX)) good value, as both are trading at around a -13% discount to net tangible assets.

Meanwhile, expectations are low across the A-REIT portfolios. Comparable rental growth is unlikely to exceed 0-2.5%, in the broker's view. Earnings guidance for 2020 is expected for the first time from Scentre Group and the broker considers there to be possible upside risk depending on assumptions around the $800m buyback.

There are expectations Goodman Group ((GMG)), which has guided to 9% growth in FY20, will increase its forecast. Stockland ((SGP)) has guided to flat free funds from operations of 37.4c per security, which Morgan Stanley expects will be maintained, despite the closure of Harris Scarf hurting the business more than peers.

The broker considers the second half earnings skew for Lendlease ((LLC)) could be as extreme as 65%. Hence, the first half result on February 20 could look very weak, simply because all major origination projects are unlikely to crystallise until the second half.

In contrast, the broker expects a 53% bias towards the first half for Mirvac Group ((MGR)), driven by an unusual settlement profile for apartments that is weighted to the first half.

A-REITs & JeansWest

Australian fashion retailer JeansWest has been placed in voluntary administration. JeansWest currently operates 146 stores with over half of these in shopping centres owned by the listed A-REITs. For now, the retailer will be trading while a buyer is sought but there is a risk of store closures.

Scentre Group is considered the most exposed with 16 stores, followed by Vicinity Centres with 15 and Stockland with 11. Morgan Stanley points out it is not that unusual for retailers to fail early in the year, as businesses will typically attempt to trade through the busy Christmas period before declaring themselves insolvent.

There have been a number of major chains that have announced store closures in the first two weeks of the year, such as Harris Scarf, Bardot and Curious Planet. Moreover, Australia's bushfires have placed additional pressure on retailers with Mosaic Group ((MOZ)), which owns Noni B and Millers, flagging a -8% drop in comparable sales growth in the first half. Morgan Stanley retains a cautious view on retail A-REITs.

Wealth

Retail wealth management platforms have been battling outflows while industry funds continue to gain share. Credit Suisse notes most of the share of flows went to industry funds in the September quarter, up $11bn, while retail funds experienced outflows of -$5bn.

Netwealth ((NWL)), HUB24 ((HUB)) and Macquarie Group ((MQG)) all received sizeable inflows at the expense of AMP ((AMP)), National Australia Bank ((NAB))/MLC and ANZ Bank ((ANZ)).

Specialists continue to win market share away from large institutions although Credit Suisse notes Commonwealth Bank ((CBA))/Colonial and Westpac ((WBC))/BT managed to maintain market share.

Financial markets are pricing in a 40% chance of a cut to the cash rate in February and with HUB24 and Netwealth generating around 55-75% of profit through cash administration fees Credit Suisse suggests their approach to managing this income is critical.

While the next 25 basis points of cash rate reductions is manageable, the broker still expects sentiment to be very negative around a cut and HUB24 is most exposed. Citi economists expect both should be able to maintain their cash margins.

The broker upgrades Netwealth to Buy, envisaging upside to near-term earnings from better-than-expected flows. The broker believes an increase in adviser churn is positive for both companies and calculates recent churn from major institution-owned/aligned dealer groups could represent up to $60bn of addressable funds under management.

Meanwhile Findex, an advisory firm with $17bn under advice, has launched a new offering with a flat administration fee of $369 per annum. This pricing is materially lower than current platform pricing and represents a risk to medium-term forecasts, in the broker's view. However traction could take time to materialise as it requires investment in sales and marketing.

Gaming

The Western Australian government has commenced a process to sell its TAB, Australia's third-largest TAB, with a final decision likely this year. Several global operators are reportedly bidding as well as Tabcorp ((TAH)).

From a strategic and financial standpoint a successful purchase by Tabcorp is plausible, given it is the only reported bidder with an existing retail footprint in Australia, but Morgan Stanley considers the upside marginal.

An acquisition could stretch the balance sheet, depending on the price paid and how it was financed. If Tabcorp is not successful, then this could bring in a stronger global competitor that would remove the company's monopoly presence and lead to greater market share loss in the longer term.

US Census

Every 10 years the US hires people to conduct its census. Thousands of temporary workers carry out data collection which causes massive fluctuations in labour statistics. Morgan Stanley highlights the upcoming census may have an impact on the 2020 federal government hiring for the first half of the year.

The broker believes it will be difficult to find the 500,000 workers which the Census Bureau plans to employ, given a 50-year low in the unemployment rate. Changes in technology may alleviate some of the stress and the broker assumes a peak of 400,000 temporary workers will be hired.

Morgan Stanley points out that workers are quickly shed in June and this will net out to roughly zero by November. This will have no bearing on average hourly earnings as that is a measure of private sector pay, although it will create swings in aggregate income, expenditure and savings in the first half versus the second.

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