The Wrap: Margins, Mortgages & Malls

This story features NETWEALTH GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: NWL

Cash margins of investment platforms could be under pressure in the near term; Telstra taking small and measured steps for now; favourable demographics expected to lead to a rise in mortgage lending activity.

-Cash rate cut poses headwinds for specialist investment platforms
-Telstra 5G fixed broadband: first thoughts
-Mall Maladies
-Mortgage market activity picks up pace

-By Angelique Thakur

Implications of a cash rate cut for investment platforms

With the Reserve Bank of Australia expected to possibly lower the cash rate in October (or maybe November), Citi tries to ascertain the impact such a cut would have on the cash margins earned by specialist investment platforms Netwealth Group ((NWL)) and Hub24 ((HUB)).

A -15bps rate cut in October would hit Netwealth’s FY21 net profit by -4%, Citi estimates, with Hub24 negatively impacted by -8%.

In fact, margins earned from ANZ Bank on pooled cash has been highlighted by Morgans before as a short-medium term risk for the platforms. An estimation by Morgans’ analysts puts the margin at 20-30bps above-market. So. if ANZ were to cut its margin offered, this would imply a headwind to both the platforms.

Reassuringly, both have contracts in place but Morgans calculates every -10bps reduction in the cash margin in FY23 would entail a circa -4-5% negative impact on the earnings for Netwealth. Hub24 will see a larger impact at circa 6.5-7%, adds Morgans.

Looking at ways to offset the impact on earnings, Citi suggests the platforms could increase other fee components. It is unlikely the platforms would resort to a negative client cash rate. 

Citi notes both platforms' share prices could be weighed down by a further rate cut. A decline in revenue margin would offset any potential upside from higher than expected flows in the near term.

Having said that, Citi continues to see both the platforms as beneficiaries of the structural shift in the wealth management landscape, leading to solid medium-term earnings growth. 

Despite Netwealth’s scale advantage and a stronger balance sheet, Citi finds Hub24 more attractive from a valuation standpoint.

Morgans analysts retain their Hold rating on Netwealth, noting the current valuation is full but asserting the company is high quality and well-positioned to continue to deliver consistent, long-term growth. Hub24 is downgraded to Hold from Add, with the stock trading in-line with its valuation. The broker believes Hub24 can deliver a step-change in earnings over the next three years.

Telstra's 5G broadband – Fast but measured

Telstra's ((TLS)) widely anticipated 5G fixed wireless broadband product was released on October 1. Priced at $85 per month with 500GB data, the product will offer typical download speeds of 50Mbps-300Mbps.

Comparing this with the telecom’s existing mobile broadband plans, the plan sits at a circa 13% premium to Optus' $75 5G unlimited plan although is slightly cheaper than Optus' $90 Entertainer 5G plan.

UBS suspects the strategy of the telecom is to keep its footprint small and targeted at first. Here, UBS reminds Telstra will also need to be careful about its NBN non-compete agreement restrictions with respect to disconnection payments, the "substantive adverse impact clause", and consumer laws for marketing 5G as an alternative to NBN.

Notwithstanding that, UBS believes each existing Telstra fixed broadband customer (of which there are 4m in total) migrating to 5G could be extremely earnings accretive.

UBS’s analysis suggests 5G products could add about $100m-$500m to long-term fixed operating income assuming 10-30% penetration. But cash flow benefits will be less and there may be upward pressure on medium-term capital expenditure if the uptake of 5G home broadband is meaningful, the broker flags.

A challenging short-term outlook for Australian malls

UBS has assessed market quality regarding the more than 500 malls in Australia, taking into account demographics and competition in a bid to better understand the portfolio quality of major shopping-centre owners.

Short-term, the outlook post-covid for malls remains challenging, assert UBS' analysts.

Noting demographic market quality, which includes the population and wealth of the area, UBS believes Mirvac Group ((MGR)) offers the highest quality. On the flip side, the REIT also has the highest level of competition in its catchment area.

The demographics of both Scentre Group ((SCG)) and Vicinity Centres ((VCX)) are comparable but UBS finds Scentre Group fares much better after adjusting for competition.

Vicinity Centres’ portfolio consists of mixed-use projects surrounded by quality demographics. UBS highlights longer-term potential not visible in its current share price.

To determine the best locations, UBS ranks the shopping centres around Australia (more than 20k sqm).

Demonstrating its portfolio strength is Scentre Group, with 13 assets (comprising 75% of the REIT’s total portfolio) in the top 20.

At a time when the leasing power has shifted to retailers, there is income uncertainty with vacancy expected to materially increase over the next 12 months, hence the outlook for malls looks challenging. UBS’ least favoured stocks are Scentre Group and Vicinity Centres.

Having said that, the broker does not expect any forced de-leveraging in the short-medium term, especially after Scentre Group’s hybrid issuance and Vicinity Centres’ capital raising.

The key debate now is about the extent to which rents will be re-based as well as occupancy levels.

UBS’s preferred picks include the Mirvac Group, Lendlease Group ((LLC)), Aventus Group ((AVN)), Centuria Capital Group ((CNI)) and Charter Hall Retail REIT ((CQR)).

Premium Pickle

Since their respective FY20 results, both Medibank Private ((MPL)) and nib Holdings ((NHF)) have underperformed the ASX200.

Goldman Sachs suspects underperformance is driven by the delayed premium rate increase (deferred to October 1 from April 1) as well as an unclear claims growth trend. Uncertainty has only gone up over the year, with many indicating the private health insurance industry was seeing “windfall” covid related gains.

A prolonged Victorian lockdown has only made the situation worse with the lack of a favourable earnings and dividend profile the final nail in the coffin (especially relevant in Medibank’s case).

However, with the impending reopening of the Victorian health system (and easing of elective surgery restrictions), Goldman Sachs now has a clearer idea around the claims savings from the second lockdown.

In the broker’s view, these savings are expected to be material. Nevertheless, there are still many unknowns surrounding how the second wave will be treated by the regulator (APRA), that required 100% of hospital savings from the first lockdown to be set aside for the "catch-up" in FY21.

Some of the key questions pertain to the quantum of provision the industry needs to set aside for the second wave in Victoria and how much of the expected claims saving from the second lockdown has already been factored into the FY20 covid provision process.

Goldman Sachs thinks claims savings through FY21-to-date will more than cover the already announced FY21 customer relief measures like the partial waiver in premium increase for 2020, but not a full waiver of the increase.

With respect the rate increase of October 1, Goldman Sachs believes it will be a “positive catalyst” for both Medibank and nib Holdings.

With growth metrics looking fairly solid along and a good scope for permanent savings to contain the 2021 rate increase, Goldman Sachs thinks risks will become evenly balanced.

The broker upgrades Medibank to Neutral while retaining its Neutral rating on nib.

Tailwinds in the mortgage market

Citi analysts flag a recovery in housing and mortgage activity with concerns easing around responsible lending and record low rates raising buyers’ attention. It looks like the mortgage sector is on the road to recovery after the setbacks from the Royal Commission.

A deep-dive analysis of the Australian mortgage market shows mortgage brokers are poised to win market share.

One of the tailwinds will be the people in the age group 35-54 years, suspects Citi. As this segment is considered the ‘house with a mortgage’ demand demographic and over the next 10 years, Citi analysts anticipate a boom in this segment.

Another tailwind could be the transformation of branch networks, a major cost head for the revenue strapped sector, to the benefit of independent mortgage brokers.

Citi emphasises mortgage brokers, led by Australian Finance Group ((AFG)), are increasingly turning to fund their own branded mortgages through securitisation. The stock is the broker's preferred play, with a Buy rating. The group looks set to control almost 40% of the broking industry, Citi believes.

Citi also rates Mortgage Choice ((MOC)) as Buy, noting its franchise business model has put the business in a better place to utilise a strong consumer-facing brand in a growing market.

While Australian Finance Group is its preferred pick, Citi finds Mortgage Choice to be the value play of the mortgage sector.

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