The Wrap: MYEFO, Banks, Telcos And Tourism

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MYEFO numbers; mortgage re-pricing; La Nina; opportunities for small telcos; increased Oz tourism; and Citi's update on small cap stocks.

-Mortgage market dynamics may be hurting smaller banks
-Lower likelihood of cyclonic activity will benefit insurers
-Addressable markets for smaller telcos increasing with NBN roll-out
-Increased Oz tourism positive for small leisure sector
 

By Eva Brocklehurst

MYEFO (Mid Year Economic and Fiscal Outlook)

Should a preview attempt to forecast numbers that Treasury is expected to publish in the document or should it contain those numbers that the broker ultimately expects a few years down the track? This is the question Deutsche Bank asks. The broker does both. On account of higher commodity prices, Treasury's nominal GDP growth forecast for 2016-17 is likely to be revised higher. The broker expects a forecast of 4.75% this year, up from 4.25% expected at the time of the May budget.

Yet, even a mild pullback in commodity prices combined with weakness in wages growth means that the GDP growth forecast for 2017-18 is likely to be well below the May budget forecast of 5%. Deutsche Bank forecasts nominal growth in that year at 3.25% and suspects Treasury will settle for 3.75%. The report is expected to show a weaker fiscal position compared with the May budget.

Specifically, the broker expects a forecast for a budget deficit of $36bn into 2016-17 and $26.3m in 2017-18. Deutsche Bank suspects Treasury may just manage to estimate that the budget will be in balance in 2020-21. Yet, further out, getting beyond a budget balance into even a very modest surplus is expected to be difficult.

Deutsche Bank forecasts a long-run, nominal growth rate of 4.75% instead of Treasury's 5% and this assumption suggests it is unlikely, on current policy settings, the budget will ever return to surplus.

Banks and Mortgages

Banks have announced another round of mortgage re-pricing, most of this being centred on the investor, line-of-credit categories. Deutsche Bank believes the motivation was to repair the profitability of mortgage books and to widen the gap between investor and owner-occupied pricing.

The broker estimates the full benefits for the majors to be 1-2 basis points to net interest margins and 0.7%-1.5% to net profit. The broker does not believe the impact on credit quality will be material, given the small scale of the re-pricing.

While the major banks focused their efforts on investor, interest-only and equity line-of-credit mortgages, the smaller banks such as Bendigo and Adelaide Bank ((BEN)) and ING Direct increased both investor and owner-occupier mortgage rates.

Bank of Queensland ((BOQ)) is yet to follow suit, but Deutsche Bank suggests market dynamics may be hurting smaller banks compared with the majors, which may reflect the relatively high spread in RMBS markets at present.

Morgan Stanley does not change forecasts based on the latest re-pricing, as it already assumes some further moves will be made in FY17. The broker believes an ongoing reduction in home loan and deposit competition is necessary to limit the downside risks to margins. The broker believes Bank of Queensland should also re-price its residential home loans to help alleviate downside risk on margins.

Commonwealth Bank ((CBA)), the remaining one of the big four yet to make a move, has recently increased fixed-rate home loan pricing. The broker also observes, separately, this bank has made it more difficult for its customers to switch an existing home loan to interest only.

General Insurers

The likelihood of La Nina conditions in the upcoming cyclone season is considered low and Morgan Stanley observes this reduces the chance of above-average storm damage and flooding. This bodes well for insurers, with catastrophe losses around 60% lower in neutral versus La Nina years.

The outlook from the Bureau of Meteorology has been downgraded to Inactive from Watch, although some weak La Nina patterns continue. Morgan Stanley notes, Insurance Australia Group ((IAG)) has greater leveraged to a more benign cyclone season versus Suncorp ((SUN)).

Telecommunications

As the NBN roll-out accelerates in FY17, infrastructure-owning telcos are facing increasing headwinds to their margins because of higher access costs. Yet, Goldman Sachs observes the roll-out is also benefitting overall subscriber growth and increasing the addressable markets of the smaller telcos.

The broker believes there are several market opportunities for TPG Telecom ((TPM)) and Vocus Communications ((VOC)).

The roll-out in up to 1.8m households categorised as "undeserved” is just 20% complete and the broker envisages a strong tailwind for market growth the next 3-4 years. As the two companies charge materially higher prices in regional Australia because of the lack of infrastructure, the roll-out of the NBN is considered to be a significant opportunity.

The broker estimates 2.3m regional ADSL subscribers will migrate to the NBN over the next five years. Thirdly, as the hybrid fibre coaxial (HFC) network is transferred to the NBN, the competitive advantage for both Optus and Telstra ((TLS)) across these 1m subscribers will be removed.

Hence, while acknowledging significant margin headwinds, the broker believes TPG Telecom can continue to grow its consumer earnings through subscriber growth and FTTB (Fibre To The Basement) network. The broker retains a Buy rating on the stock.

Goldman Sachs remains constructive on Vocus Communications' consumer earnings, given it does not face NBN margin headwinds and should benefit from an increased addressable market including regional Australia. The broker has a Neutral rating on the stock.

Tourism

Citi notes outbound travel continues to slow while arrivals are strong. Australian resident short-term departures grew 3.4% in October, representing the third consecutive month of slowing growth. Meanwhile, arrivals increased 11.1%, representing the 11th consecutive month of double-digit growth.

The broker notes a lower Australian dollar will lead to outbound travel becoming more expensive, which should translate to more Australians taking domestic holidays and Australia becoming more attractive to foreign tourists.

The broker envisages increased Australian tourism will be positive for the small leisure sector such as Ardent Leisure ((AAD)) and Village Roadshow ((VRL)). Mantra Group ((MTR)) should benefit through its hotel operations.

Small Caps

Citi believes Sino Gas & Energy ((SEH)) offers material upside potential. The key steps to de-risking the stock include commencement of the payments from Sanjiaobei and a re-start of the project, both imminent. As well, reserve upgrades are expected in the first quarter 2017 and approval of the overall development plan in the second half or into 2018.

The broker initiated coverage on seven small cap stocks in the December quarter, including two Buys, these being MYOB ((MYO)) and Sino Gas. There are three Sell initiations including a2 Milk ((A2M)), Bellamy's Australia ((BAL)) and Smartgroup ((SIQ)) and two Neutral including News Corp ((NWS)) and Trade Me ((TME)).

The broker has upgraded OceanaGold ((OGC)) to Buy from Neutral and four – Charter Hall Retail ((CQR)), Premier Investments ((PMV)), Regis Resources ((RRL)) and Shopping Centres Australasia ((SCP)) – to Neutral from Sell. Ardent Leisure, Beach Energy ((BPT)), GUD Holdings ((GUD)) and Resolute Mining ((RSG)) are downgraded to Neutral from Buy and Sigma Pharmaceuticals ((SIP)) to Sell from Neutral.
 

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