In Brief: Banks, Beef, Housing Construction & The US Economy

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

Technology for banks; lower beef prices; the next housing construction boom; housing developers & the US debt ceiling.

-Which Australian bank is gaining a technology advantage?
-Lower Australian beef prices and competition from Argentina
-Beneficiaries of the next housing construction boom
-Record construction sector insolvencies weigh on developers
-Impacts from debt ceiling legislation on the US economy

By Mark Woodruff

Which Australian bank is gaining a technology advantage?

The global structural shift towards 'digitisation' in banking has accelerated since the onset of the covid pandemic and is being enhanced by greater use of artificial intelligence.

Hence, digital capability and the 'everyday banking experience' for customers will be critical to a sustainable competitive advantage for Australian banks, according to Morgan Stanley, and will require ongoing investment in technology and talent.

The way in which technology is being adopted by customers should significantly impact the service proposition delivered by Australian banks, suggests the broker, and result in material cost efficiencies and risk mitigation via enhanced cyber security.

The capability of banking apps is considered the key to delivering these benefits.

Over time, the app has become far more sophisticated to the point where it is now the portal for the ‘digital ecosystem’, which offers additional and adjacent products and services to the customers.

The early banking apps were still shop fronts but were easier for customers to visit than bank branches, explains the broker. Now, apps are more like platforms, with customer visits more frequent and for longer periods of time.

According to the Morgan Stanley App Scorecard, which assesses the core and secondary capabilities of 14 different banking apps in Australia, CommBank ((CBA)) is leading the field in 2023, due to its budgeting, as well as its lifestyle and loyalty features.

Interestingly, the analysts point out CBA appears well ahead of the other major banks in its current use of AI, as well as its appetite for further development.

CBA’s ongoing technology diffusion leadership (it also led in 2019 and 2021) suggests to the broker potential for better-than-peer margin and revenue outcomes, though an Underweight rating is maintained on the bank’s cost growth outlook.

One of the main advantages of AI is the automation of decision-making processes, which can be used to improve existing products or launch new products. 

A good example of the latter, observe the analysts, is the development of end-to-end digital mortgages, which is now a far more pleasant customer experience compared to the physical mortgage process.

Another advantage of AI is better recognition and reward for customer loyalty to a particular product or service.

Returning to Morgan Stanley’s Scorecard, Westpac ((WBC)) is now coming second, having narrowed the gap on CBA, particularly in the areas of payments and security.

National Australia Bank ((NAB)) has slipped to sixth, due to relatively weak scores in savings, budgeting, and lending.

The performance of ANZ Bank ((ANZ)) has improved overall, but the original ANZ app is ranked seventh and the recently launched ANZ Plus ranked only tenth.

Lower cattle prices lower and increasing export competition from Argentina

Increased cattle numbers in Australia are leading to higher slaughter volumes and lower cattle prices for the local beef sector, according to Radobank.

Many rural areas across Australia are close to normal breeding numbers, notes the bank, and there is now less urgency by cattle producers to buy young and replacement stock.

In mid-May, the Eastern Young Cattle Indicator (EYCI), a seven-day rolling average of young cattle prices, was down -43% on the previous corresponding period.

Australia could also be facing increased competition due to greater exports originating from Argentina. The country remains one of the largest producers, consumers and exporters of beef in the world.

Radobank explains Argentina has become more competitive on world markets following its currency devaluation, and there has been increased demand from China, which accounted for 77.6% of the country’s exports in 2022.

In addition, Argentinian beef consumption has been slowly declining over the last 30 years and reached its lowest level in 2022, which the bank mostly attributes to the cost of beef, which has risen by more than 35% (in US dollar terms) since January 2019.

Beneficiaries of the next housing construction boom

Current consensus thinking is to be underweight housing cyclicals on the Australian share market, yet Jarden is already reviewing opportunities and beneficiaries of the next housing construction boom.

The next 12-18 months will be challenging for the housing/construction sector, especially as the broker forecasts higher-for-longer interest rates and ongoing downside risks to the current house price recovery.

More positively, interest rate cuts in late 2024 are expected to kickstart a construction boom which could rival the 2015-2018 cycle.

Prior to any upturn, Jarden sees near-term downside risk to earnings, particularly for Building Materials and Retailers, as weak demand and elevated costs put downward pressure on margins. Residential REITs should also be negatively impacted via lower settlements.

The seeds for the turnaround should come from surging migration levels, suggests the broker, and a more supportive regulatory environment for build-to-rent, via withholding tax and depreciation changes in the FY24 budget.

Moreover, Jarden anticipates increasing pressure from both State and Federal governments to streamline development and unlock more housing supply.

The above three turnaround factors will need to be supplemented by an improvement in affordability driven by a combination of lower interest rates and construction costs, stress the analysts.

From among Jarden’s research coverage, stocks with the greatest leverage to a new housing construction boom are: Beacon Lighting ((BLX)), CSR ((CSR)), Metcash ((MTS)), Stockland ((SGP)) and Wesfarmers ((WES)).

If rate cuts and prices drive a broader pick-up in volumes and activity, the broker sees greatest leverage via Harvey Norman ((HVN)), JB Hi-Fi ((JBH)), Nick Scali ((NCK)), Pexa Group ((PXA)) and REA Group ((REA)).

While the Australian housing cycle is positive for Fletcher Building ((FBU)), only circa 20% of its earnings are exposed to Australia with the remainder relating to New Zealand, point out the analysts. It’s thought the housing cycle in New Zealand is lagging Australia by six-to-nine months, with more downside expected.

Jarden also reminds investors global exposures to BlueScope Steel ((BSL)), James Hardie ((JHX)) and Reliance Worldwide ((RWC)) limit upside leverage to a renewed Australian housing construction cycle, while a higher share of non-residential construction reduces the leverage of both Adbri ((ABC)) and Boral ((BLD)).

Record construction sector insolvencies weigh on developers

Given the size and scale of ongoing failures in the construction sector, where insolvencies have risen to record levels, Jarden questions whether collateral damage may spread toward developers.

Cash flows are a historically weak point for the construction industry, explains the broker, given high upfront costs combined with deferred revenues, and profits are generally very concentrated at the back end of projects. 

Moreover, the industry has experienced multiple disruptions and challenges including the lagged impact of lockdowns, higher material costs/supply chain issues and labour costs/shortages.

Also, the analysts note a combination of intense competition and fixed fee contracts has led to the current crisis.

The broker hosted a panel of construction/insolvency lawyers who expect elevated financial stress will continue for the next 6-12 months. This projection was broadly in line with Jarden’s earlier channel-checks.

Current construction sector woes could lead to delays and cost overruns for developers, adding to stresses from weak demand, especially for residential, explain the analysts.

Additionally, developers are already contending with high costs, higher interest rates and difficult financing conditions. Residential developers (particularly multis) are also facing uneconomic original purchase prices due to cost increases, as well as buyer attrition, with many buyers facing settlement difficulty.

Overall, the risk posed to developers, brought to light by the panel discussion, was greater than Jarden had forecast, though the continued demand for development sites suggests potential for a strong rebound in construction activity in time.

Separately, the broker points out the growth of non-bank lending to residential development has to some extent reduced the bad loan risk posed to banks.

Impacts from debt ceiling legislation on the US economy

Spending concessions arising from the Fiscal Responsibility Act (FRA) will only have a modest negative impact on the US economy, according to Oxford Economics.

The US Senate is expected to pass the legislation, allowing Treasury to avoid missing any payments on obligations due early next week.

A deal was struck between President Biden and House Speaker Kevin McCarthy that will suspend the debt limit and restrain government spending.

Oxford forecasts the FRA will knock no more than -0.3 percentage points (ppts) off real GDP growth in 2023 and be a -0.1ppts drag in 2024. 

Also, it’s expected the unemployment rate would rise by 0.2ppts and payrolls would be about -375,0000 lower by the end of 2024, relative to the current baseline forecast.

While the Congressional Budget Office predicts outlays will be reduced by -$1.3tn over ten years, there are "agreed upon adjustments" between President Biden and House Speaker McCarthy that are expected to soften spending reductions over the next two years, explains Oxford.

Because of their vague nature, such side agreements were not included in forecasts by Oxford Economics, but they could reduce the magnitude of the FRA's spending cuts to around -US$1tn. 

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