In Brief: Business Risk, Regional Banks, Telecommunication Infrastructure, Classifieds

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Weekly broker wrap: Rising business risk and stress, near-term benefit for regional banks, telecommunications infrastructure retains premium, classifieds comparison.

-Insolvencies on the horizon amid rising business risk and stress
-Regional banks likely to gain near-term benefit from rising rates
-Recent sales suggest rising rates not weighing on telecommunications infrastructure premiums
-Positive outlook for automotive listings, employment listings likely to normalise

By Danielle Austin

Slow acceleration on insolvency action raises business risk and stress

CreditorWatch has demonstrated increased insolvency risk for some industries as the Australian Taxation Office, and many financiers, remove grace periods for companies in arrears, exposing those who have been trading unprofitably since 2020. Further, CreditorWatch highlighted that amid rising rates, the cost of debt is only increasing.

Analysis by CreditorWatch revealed almost all industries saw an increase in the number of businesses in arrears by 60 days or more, and while construction remains the sector with the largest number of late payers, the CreditorWatch June Business Risk Index found the highest risk levels in the Food and Beverage and Arts and Entertainment sectors.

Insight from Jarden has revealed business insolvencies have risen slightly, still remaining significantly below normal levels, but commentary from insolvency and restructuring partners suggests business stress is rising. These insolvency advisors noted they have experienced an increase in customer engagement as debt overhang, cost pressures, supply chain constraints, labour issues and rising rates all drive up business stress.

With insolvencies brought by the Australian Taxation Office largely subdued over the last two years, analysts had been predicting a ramp-up in activity post-election, but acceleration has been slower than expected. Jarden is now anticipating the ATO will step up collection and enforcement of overdue lodgements in the next year, highlighting collectable debts in FY21 were up 50% on pre-covid levels and are expected to have now increased a further 25%.

The threat of insolvency remains a key issue within the construction industry, with the sector already approaching pre-covid levels and expected to rise. Jarden noted most of this insolvency activity comes from smaller businesses with less than $1m in liabilities, but with many subcontractors taking on trade credit insurance given the outlook, risk may be passed to insurers.

The broker also highlighted homebuyers are likely most at risk of having projects left incomplete, given they are more likely to be unable to fund a higher cost build and less likely to litigate if builders walk away from unprofitable contracts. Jarden sees growing risk of pipeline work not being completed. Outside of the construction sector, Jarden highlighted manufacturing, tech, aged care, transport and discretionary retail as key industries at risk of insolvency.

Regional banks react to rate rises

Morgan Stanley has zeroed in on how rising interest rates will impact on the regional banks within its coverage. The Morgan Stanley analysts are anticipating a quick and aggressive rate hiking cycle will deliver benefits to the regional banks in the near-term, but drive increased mortgage and deposit competition next year.

The broker finds Bendigo & Adelaide Bank ((BEN)) better positioned for upcoming rate hikes than peer Bank of Queensland ((BOQ)). It was highlighted that rate-insensitive deposits account for 20% of Bendelaide’s total funding, but only 10% of Bank of Queensland’s funding, likely delivering the former a larger benefit from rate hikes. While the broker lifted its forecast for Bendelaid's FY23 reported margin 13 basis points, it expects any benefit derived by Bank of Queensland to be largely offset by competition.

That said, Morgan Stanley expects both regional banks to deliver above system growth in FY23 and FY24. Morgan Stanley notes Bank of Queensland (for which the broker is Overweight rated with a target price of $8.10) offers a longer-term pathway to improved profitability, but likes the company’s clear strategy and roadmap, while Bendigo & Adelaide (Equal Weight rated, with a target price of $10.00) offers above-peer leverage to rising rates – more confidence in emerging margin benefits and cost improvements would drive a more positive outlook from the broker.

Interest rates not a deterrent to premiums on telecommunications infrastructure

Analysis by JP Morgan suggests the premium demanded in the sale of Spark New Zealand’s TowerCo stake highlights ongoing demand for telecommunications infrastructure despite the current rate rising environment, and signifies a positive for Telstra ((TLS)) and its potential to monetise InfraCo in coming months.

The broker highlighted the NZ$900 sale represented a 38x earnings multiple, in line with other recent sales in Australia, and with Telstra set to be in a position to monetise its InfraCo interest in October the Goldman Sachs analysts note high premiums suggests bidders won’t be deterred by higher interest rates. Goldman Sachs had previously assumed a 21.6x earnings multiple valuation for the InfraCo assets, which it describes as some of the highest quality telecommunications infrastructure assets in Australia.

Pre-rate rise, similar transactions saw TPG Telecom ((TPG)) demand a 32x earnings premium for the sale of its towers, Uniti Group ((UWL)) demand a 28x premium for its yet to be settled sale, and Telstra demand a 28x premium for the sale of Amplitel.

Auto positioned to be major classifieds beneficiary post-covid

With volumes of classified advertisements anticipated to normalise in the post-covid environment, Goldman Sachs has provided insight into its medium-term outlook for the sector.

The broker remains largely positive on property listing volumes, expecting commissions to decline to allow for larger advertising spend within existing budgets in a positive outlook for both REA Group ((REA)) and Domain Group ((DHG)). Goldman Sachs analysis showed sufficient market size to support growth for both of these companies. The broker is Buy rated on both REA and Domain with target prices of $164.00 and $4.20. Noting average earnings compound annual growth rate for classifieds is 11%, the broker predicts REA will deliver a 12% growth rate and Domain a 14% growth rate through to FY25.

For employment listings, the broker remains more cautious. Goldman Sachs notes Seek ((SEK)) is the most cyclical company in its classifieds coverage, and it anticipates the company will face both volume and depth headwinds in a normalising labour market. The broker highlights greater emerging earnings risk for Seek, on which the broker is Sell rated with a target price of $22.70, despite a number of meaningful growth drivers. The broker is predicting Seek to achieve an 8% earnings compound annual growth rate through to FY25.

With volume normalisation already underway for automotive listings, the broker notes reduced near-term risk for Carsales.com ((CAR)), for which it is currently not rated. Further, Goldman Sachs analysts anticipate a successful transition to a transaction-based model offers meaningful earnings upside, and is forecasting a 10% earnings compound annual growth rate through to FY25. When considering potential investment, Goldman Sachs finds automotive classifieds best placed to experience upside risk to volumes, and employment the worst placed.

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