Weekly Broker Wrap: Term Deposits, Supermarkets, Sales And FX Strategy

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-Flat cash dampens term deposit rates
-Food inflation downside for supermarkets
-Would Woolworths exit Masters?
-Business sales growth softest in 2 years
-More declines likely for Aust dollar vs US

By Eva Brocklehurst

Term Deposits

Term deposits are now less attractive for investors, Morgans notes. Recent reductions in rates in the face of a flat outlook for the official cash rate and changing regulation regarding breaking deposits have done the trick. The broker expects that term deposit rates will decline further over the coming year, as wholesale credit market continue to offer attractive funding sources for financial institutions.

Clients should hold deposits as part of a diversified portfolio but, for now, Morgans considers they are less appealing. Interest rates will increase at some point but the broker believes investors should focus on equities with increasing dividends. These companies will be better able to withstand a rising interest rate environment when lower risk alternative investments become more attractive. In this case, the broker is a buyer of ANZ Bank ((ANZ)), Pact Group ((PGH)), Stockland ((SGP)), Sydney Airport ((SYD)), Transurban ((TCL)) and Telstra ((TLS)), given the attractive yields on offer.

Food Inflation

Food inflation may disappear by mid 2015, in Citi's view, given the fall in soft commodity prices. Citi estimates this will reduce comparable store sales growth and compress price/earnings ratios for the supermarkets. The broker estimates share price downside of 15% for Metcash ((MTS)), 11% for Wesfarmers ((WES)) and 9% for Woolworths ((WOW)) from a lower food inflation scenario. The potential earnings downside for the three is 3-5%, while comparable store sales growth could drop to less than 1%. The broker cites a 12% decline in sugar prices, 20% for wheat and 34% for dairy. A wide range of other inputs have fallen as well, such as packaging and oil prices.

The correlation between soft commodity prices and retail food price inflation is high. The broker's indicator shows food inflation may have a near-term peak in the December quarter this year and decelerate by 270 basis points by June 2015. Soft commodity price tend to move around nine months ahead of shelf price changes.

Woolworths Exit From Masters?

Deutsche Bank confronts the scenario of a Woolworths exit from the struggling Masters hardware business. The broker expects the joint venture with Lowe's will persist with Masters for some time but, eventually, if the business does not improve, an exit cannot be ruled out. The analysis suggests an exit would be positive for Woolworths' cash flow, even if Masters could not be sold as a going concern. Deutsche Bank assumes the Home Timber & Hardware business, in this analysis, would be retained, as it is profitable. In reality, if the JV exited Masters, there would be few reasons to retain ownership of a predominately wholesale business but it could be sold as a going concern for a reasonable price. Fixed assets account for the most of the assets held in the JV.

On a worst case scenario, where Masters is not sold but assets are liquidated and liabilities settled, Woolworths would be left with residual cash of around $189m. This would not be a great outcome given the $1.7bn already invested but as the money has already been spent, future cash flow should be of more concern to investors in the broker's opinion.

Business Sales Indicator

Sales growth, economy-wide, was at its softest in two years in October. The Commonwealth Bank's Business Sales Indicator showed spending rose in 14 of 19 sectors but increased just 0.3% overall. The positive take on the numbers is that sales have increased for 39 months consecutively. Annual growth in seasonally adjusted sales eased to 8.0% from 9.2% but remains above the 6.4% long-term average. The five industries in which spending fell in the month were mail order/telephone order providers, government services, automobile/vehicle rentals, utilities and automobile/vehicle sales. NSW did not have any increase in sales in the month. The flat result follows generally strong growth over the past 25 months in that state. ACT led the gains by state or territory, up 1.7%, while Western Australia, South Australia and Tasmania rose 0.7%.

FX Strategy

Strategically, ANZ strategists retain a strong US dollar bias but expect the short term trading environment will be range bound. Global inflation dynamics are clouding the issue regarding what the US Federal Reserve might do with its key funds rate in 2015. The strategist note that as the volatility in the bond market has declined, that of the FX market has risen. Consolidation is expected ahead of a return to US dollar strength next year. Low inflation risks will dominate the euro debate while the strategists suspect the market is under-pricing the interest rate trajectory in Britain.

The Australian dollar is expected to continue to weaken in 2015. The strategists note the Australian dollar's recent decline against the US dollar has only kept pace with the decline in key commodity prices and has not resulted in a reversion to fair value. They suspect that the currency will be weaker than previously envisaged through 2015 and have revised down their 2015 year-end target to US82c from US85c. Even at this level the decline is not expected to be sufficient to provide a substantial and independent boost to the Australian economy, nor accelerate the pace of Reserve Bank policy tightening. Little domestically induced recovery is expected for the local currency in 2015 either, and the strategists lower their December 2016 forecast to US80c.
 

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