Weekly Reports | Oct 01 2012
By Eva Brocklehurst
As the Reserve Bank board meets on October 2 for its monthly mulling over the forces in the economy, and ponders whether to carve off some more points from its official interest rates (and a number of economists suggest they will), the markets are doing their best to muddy the picture.
The overriding emphasis has been on mining, and coal and iron ore prices. It is now a case of, well, the peak has passed, where will any gap/opportunity come in the country's continued wealth creation?
A lot has been said about other sectors and how they struggle in the midst of all this focus on mining investment. Do they stand ready to pick up any opportunity? Can they take advantage of lower interest rates? According to economists at Bank of America Merrill Lynch, it might be not be all gloomy in the commodity country for its tourist industry, fraught for several years by the high Australian dollar which has made tourist arrivals slump.
The hallmark was Cyclone Yasi's devastating impact a couple of years ago on its psyche. After all, Far North Queensland, with its large economic dependence on tourism felt the financial devastation. However, the analysts are now mentioning …tailwinds!
Merrills says, despite soft consumer confidence and challenging market conditions, "we are seeing potential tailwinds emerging in the domestic travel market". Domestic airfare prices are expected to hit new levels of affordability and drive an increase in passenger numbers (expected to be up 6-7%). So, they suggest a pairs trade strategy – Buy on Flight Centre ((FLT)) and go Underperform on Wotif.com ((WTF)).
The airlines team is forecasting domestic yield compression of 2.5% for Qantas in FY13 as a result of capacity additions and subsequent discounting. Nevertheless, declining yields are positive for the domestic travel industry and act as a proxy for airfare prices. Merrills continues to prefer Flight Centre as FY12 trading comments were supportive for growth in FY13. FLT remains a heavily shorted stock, however days short has decreased and the broker continues to view the short as an overplayed theme. As for Wotif.com, the analysts see some lift in the domestic travel market but are cautious on WTF given the structural challenges remain heightened and this translates into a muted EBIT (earnings before interest and taxes) growth forecast of 4.6% in FY13.
Another sector that has fallen hard is media and the upcoming AGM season (Oct/Nov) will likely tell the tale of woe. JP Morgan expects consensus downgrades across traditional media names.
There are several reasons for this including a subdued advertising market start, a lack of visibility on FY13 revenue as well as structural challenges. JPM analysis has highlighted FY13 EBITDA (earnings before interest, taxes, depreciation and amortisation) downside risk for Ten Network (-21%), Fairfax (-18%), Southern Cross Media (-13%), Seek (-9%) & Seven West (-8%).
So, stresses and strains in several sectors but a bit of hope in one that has been terribly stressed? Yes, it's muddy waters.
Lastly, what about the role of the banks?
According to UBS banking analysts, one thing that all the bank boards are likely to acknowledge is, that in tight times and with higher risks of a blow-out in defaults, cutting the ordinary dividend should be avoided wherever possible. The sector holds a big key to sentiment as a huge number of the retail shareholders are reliant on dividends as a form of income. UBS asks the question as to what bad debts could each bank sustain without needing to cut payouts.
The stockbroker notes that, with a large corporate default, banks are more likely to look through the issue than if the overall debt defaulting is a result of a broader economic slowdown. It seems, given the nature of this economic downturn, that banks have less ability to look through a deterioration in asset quality than in other cycles.
Then, a hint of a wish list.
UBS says the banks are now strong generators of free cash flow and, given the franking credit regime in Australia and shareholder desire for yield investments, there is a significant incentive for the boards to return much of this to shareholders in the form of higher dividend payout ratios. However, the question must still be asked whether this is a prudent approach in the current environment? Bank earnings are very highly leveraged to changes in asset quality and, while this is relatively benign, the higher levels of non-performing loans are not dissipating quickly.
Deputy Prime Minister Wayne Swan has a big task at hand for his mid-year economic report, which is likely to be delivered in the next six weeks. According to Goldman Sachs there are big challenges for the commitment to a Commonwealth budget surplus. Indeed, the economists flagged the RBA's Financial Stability Review, recently released, which noted increased financial system vulnerability, but continued to characterise the ongoing consolidation in corporate and household balance sheets as desirable.
This means less money is coming into the government's coffers.
Goldman says the bigger issue since mid-year is the degree to which the adverse, and unusual, falling bulk commodity prices and strong Australian dollar, both have undermined the outlook. The economists have tested the sensitivity of Australian tax revenues to a terms of trade-driven negative income shock of around 2% of nominal GDP and find there is around $20bn downside risk to forecast Commonwealth tax revenues over FY13 and FY14 – mostly via a weaker company tax take.
In contrast, a commodity price shock presents a comparatively modest downside risk to state government goods and services tax receipts, with a much larger threat posed via the outlook for mining royalties. Moreover, the economists flag that absent new efforts to claw back revenue and restrain spending, fiscal projections will fall materially short of budget. However, sufficient revenue and mitigating expenditure cuts should be found to preserve existing sovereign credit ratings.. phew.
Yes, a hard task wading through muddy water.
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