Weekly Broker Wrap: Consumers, Cheap Cyclicals And Yields

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By Andrew Nelson

Equity markets fared better during the week as investors anticipated decisive action in Europe and brokers switched focus to a few other hot topics. The Oz retail environment got a few goings over, while yield plays remained of interest and the topic of risk on versus risk off also stayed popular with analysts.

You can’t go a day reading Australian broker reports without coming across such pat phrases as the deteriorating macro outlook, the softening consumer environment, slipping discretionary sentiment etc. Yet the closer one looks at the numbers, the harder it is to find hard economic data to support these statements.

At least that’s what analysts from Deutsche Bank think when it comes to the Australian consumer environment. Last week, a pair of strategists from Deutsche set forth to untangle some of the emerging mythology contained in the consensus opinions of the domestic consumer outlook.

The first myth the team takes on is: Australian consumer spending is soft. Not so at all says Deutsche, who points to data released last week showing consumer spending is actually growing in line with historical averages, both in terms of values and volumes.

The second myth the team debunks is:  essentials spending is limiting discretionary spending. Again, the broker disagrees and points out that the opposite is actually true. Based on current data, it appears discretionary spending is actually outpacing non-discretionary spending.

So why is the retail sector so reportedly weak?  

The broker explains that this weakness is merely a perception and that the spend is out there, it’s just shifting towards discretionary spending in services, rather than goods. In fact, the broker says current levels of discretionary spend are far from being depressed, noting consumers have significantly lifted spending on transport, cafes, restaurants and gambling.

The third myth is that a shift towards saving is putting the mockers on spending. Again, the broker thinks this just isn’t so, noting the average savings rate has been pretty much flat at albeit a high level for the past three years.

The broker notes that a stable saving rate tends to lead to spending growing that is in line with income. Thus while higher savings have indeed hurt spending, it happened back in 2008-2009, which is when savings actually last rose in a significant manner. Over the past couple of years, the broker points out that spending growth has tracked income growth.

This leads the broker to think that the problem with Australian cyclicals is much more structural and less cyclical than the most seem to be thinking. And with Deutsche sceptical about the assistance that might be offered by rate cuts, which can’t fix structural issues, it stays underweight on retail, media, logistics and building materials, despite expecting another 50bp of cuts in the near to mid term.

In the longer run, the broker admits rates could fall below 2% and if this were to happen, then maybe domestic cyclicals might start looking attractive. Still, the broker would maintain a skew towards housing over consumer spending. It seems that people like to buy homes in a downturn, at least the ones that have jobs. The broker notes there are historical trends showing this, as those still with money are attracted by lower prices and the lower mortgage rates on offer.

Analysts at Goldman Sachs also covered the retail recovery topic last week in the wake of the RBA’s latest rate cut, noting interest rate cuts often fuel hopes for a surge in retail sales, seeing investors jockey for position for exposure to retail related sectors. But not so fast, warns the broker.

After taking a close look at credit and wealth trends, the broker thinks the rise in retail volumes in 1Q of this year will prove but a temporary blip. Goldman’s notes household discretionary cash flow is already negative and will likely become more negative in the near term despite rate cuts and extra cash being handed out by Canberra.

Still, the broker has a sneaking suspicion that retail sales might well have made it through the worst of the cyclical slowdown. However, Goldman’s isn’t prepared to call a bottom until sales are sustained up to and beyond the next Christmas trading period.

Yields also remained a popular topic last week, with Goldman Sachs also taking a look at yields in the Infrastructure and Utilities sectors. While the broker notes yields in the sector have fallen in recent years, they have actually declined in tandem with bond yields.

Thus while distribution yields are not as attractive on an absolute basis as they used to be, the broker points out that relative to bond yields and term deposits, yield premiums in the sector remain broadly intact. Therefore, the broker likes plays without earnings exposure to lower bond yields such as Australian Infrastructure ((AIX)) and Transurban ((TCL)), which it notes posses both solid valuation metrics and better than sector  growth outlooks.

On the other hand, the broker doesn’t like Envestra ((ENV)) and SP Ausnet (( SPN)), as both are facing upcoming regulatory reviews for Victorian gas distribution, which poses risks to consensus earnings forecasts as a result of depressed bond yields feeding through to lower allowable capital costs.

Citi takes a different tack, noting that with global government bond yields now at new lows, global equities now offer inflation-beating dividend yields plus dividend growth. The broker thinks that income starved and inflation wary investors should take note of this.

The broker likes high dividend yields coupled with solid earnings prospects, with its global basket of stocks offering a yield of 5.1%, with 7% dividend growth expected in FY12. Citi’s basket is Overweight Europe and global defensives, while Underweight on Financials. The one Australian stock in the broker’s global yield basket is Woolworths ((WOW)) with a yield of 4.7% and 6% dividend growth expected with the FY.

The broker also maintains a domestic yield portfolio, which it notes has outperformed the S&P/ASX 200 Accumulation Index by 1.38% since February. Key components of the broker's Australian yield portfolio are Telstra ((TLS)), Metcash ((MTS)), National Australia Bank ((NAB)), CommBank ((CBA)), ANZ Bank ((ANZ)), OneSteel ((OST)) and Rio Tinto ((RIO)) to name a few.

Last but not least, Goldman Sachs also looked at the return of risk aversion last week, singling out some stocks it sees as well placed to weather the storm of weak macros and falling bond yields.

Currently, the broker notes relative valuation metrics are looking very weak, while absolute valuation metrics are back at GFC levels. Thus while Goldman’s expects to see continued earnings risks for cyclical stocks, it believes P/E ratios will start to consolidate around current levels given the defensive bias of the large cap industrials and the yield support currently on offer in the marketplace.

The broker identifies four themes that should deliver value to shareholders in the current environment. First is a solid EPS profile plus solid operations and a USD exposure. Stocks in this list include Wesfarmers ((WES)), Brambles ((BXB)), News Corp ((NWS)) and CSL ((CSL)).

Next, the broker still likes investments in the mining sector that either boast increasing volumes or low-risk LNG expansion opportunities. On this list is Orica ((ORI)), Asciano ((AIO)), Oil Search ((OSH)), Woodside ((WPL)) and WorleyParsons ((WPL)).

That said, Goldman’s still prefers banks over resource plays, naming NAB and ANZ as its favourites.

Lastly, the broker recommends deep value cyclical stocks that offer upside leverage to improving markets. This list includes Qantas ((QAN)), Lend Lease ((LLC)), Sims Metal ((SGM)), Suncorp ((SUN)) and OneSteel ((OST)).

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