Waiting, Waiting For An Oz Housing Recovery

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-Gradual housing improvement seen
-More cuts to cash rate expected to help
-Key risks are economic recovery and pricing
-Fletcher Building the pick

By Eva Brocklehurst

As 2013 gets closer several broking houses have posited further cuts in official interest rates. ANZ Bank has gone out on a limb recently and called 25 basis points in reductions for each quarter next year and an eventual cash rate of 2%. Deutsche Bank has also set its sights on reductions which will bring the cash rate to 2.25% next year. Do these calls set the stage for an increase in housing activity in 2013?

The latest housing finance data did not show much life. October's numbers from the Australian Bureau of Statistics rose just 0.1% for owner occupied finance approvals. Moreover, this balance all came from an increase in refinancing existing loans. Hardly the stuff on which to base a resurgence in house building. However,  BA-Merrill Lynch points out that, looking at the value of housing finance approvals, investor housing finance was 5.5% higher and loans approved for investors accounted for 43.7% of all new loans in the month, the highest proportion since July 2008. The increase in investor housing finance approvals was primarily due to investment in new property. The broker noted investors are looking for yield and relatively stable prices in what remains a volatile investment environment.

Given the rate cutting cycle began in late 2011 the recovery so far has been relatively subdued, BA-ML contends, and cautious households and limited house price growth are likely to underpin this theme in 2013. JP Morgan sees the recent cash rate easing delivered by the RBA starting to flow through to the broader economy but also believes housing activity will be slow going. The broker expects a modest rise in overall household consumption in 2013. This may be desirable in the Reserve Bank's opinion, according to BA-ML. Without rapid debt accumulation in the household sector the central bank has scope to ease rates further and keep them low to support economic activity, thereby still discouraging outsized gains in house prices.

Looking at the building materials sector in the light of this gradual growth in housing activity, Deutsche Bank has increased FY13 earnings estimates for companies on its radar by 4%, on average. Ultimately, the broker expects lower rates will lead to a noticeable increase in housing activity and expects housing starts to increase 4.4% year-on-year in FY13 and 8.9% in FY14. House prices are expected to increase by 5% per annum in 2013 and 2014. Deutsche notes this would be consistent with other developed economies that did not experience either a banking or housing collapse, such as Norway, Canada and New Zealand, where rates have been at low levels for a long period of time. Key risks for the sector include a longer/shorter time to recovery in Australian housing and weaker/stronger pricing outcomes.

Specifically, Fletcher Building ((FBU)) is considered the most sensitive to changes in housing starts, followed by Boral ((BLD)). Fletcher Building is Deutsche's pick of the sector, followed by James Hardie ((JHX)) and Adelaide Brighton ((ABC)) – all rated a Buy. Why Fletcher? Well, the NZ recovery is underway and the Christchurch rebuilding is gaining momentum. Key downside risks for Fletcher include cost escalation, a prolonged downturn in the Australian and NZ housing markets and weaker non-residential and infrastructure demand. CIMB and BA-ML also rate Fletcher as a Buy on the FNArena database. Adelaide Brighton, meanwhile, has a strong market position and a positive impact from price increases, according to Deutsche. This is supported by the four Buy ratings on FNArena's database along with four Hold ratings. Key downside risks for Adelaide Brighton include a continued downturn in the Australian housing market.

Deutsche notes Hardie has strong leverage to the US recovery and potential for margin expansion. However, Deutsche is the only one to rate the stock a Buy on FNArena's database. There are four Sell and three Hold ratings. There is a wide range of target prices on this stock, with $7.70 (CIMB) to $9.50 (BA-ML). Why? Most have stuck to recommendations based on valuation, preferring to retain doubts on potential upside until further signs of housing recovery are there.

For Boral, which Deutsche rates Hold, the broker sees both upside and downside risks. For upside there is a faster turnaround in the Australian housing market (especially NSW) and cost-cutting initiatives may yield a better outcome. Key downside risks include pricing weakness in cement and concrete in Australia with the threat of import parity, as well as a continued weak US housing market. Boral has four Hold ratings on FNArena's database with three Sells and one Buy (UBS). CSR ((CSR)), in Deutsche's view, also holds both downside and upside risks. Downside includes a stronger-than-expected Australian dollar, softer aluminium prices and a slower recovery in the Viridian Glass business. Key upside includes a faster turnaround in the Australian housing market (especially NSW and VIC), stronger pricing outcomes (bricks, glass and fibre cement) and weaker than expected AUD/USD (positive impact on glass margins). These diverse risks are also reflected in the mixed recommendations on the FNArena database with four Hold, three Sell and one Buy (CIMB).

Deutsche also makes some observations about GWA Group ((GWA)). While GWA imports 70% of its product range, should the AUD/USD decline significantly, this may lead to importers pulling back volumes in the mid-term. This may positively impact GWA's market share and earnings. Nevertheless, Deutsche retains a Sell rating, the only one on FNArena's database amongst five Hold ratings. Those with Hold ratings see the company's cost cutting efforts in a slightly more positive light. Deutsche accepts that, should management's efforts at restructure and cost cutting prove more effective, it could lead to upside for the stock. 
 

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