Weekly Broker Wrap: The Myth Of Oz Housing Undersupply

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By Andrew Nelson

Last week saw brokers again discuss the continued better than expected performance of the Australian retail market. Mixed signals from the domestic property market also featured, as did the outlooks for the domestic steel, mining and insurance sectors, along with a quick peek at high end US consumer activity.

Despite the popular belief that Australian retail conditions are continuing to soften, UBS reports that retail sales are continuing to outperform what are admittedly weak forecasts. In May, retail sales were up 5% from the month prior, which served to lift the annual pace to 3.5% growth from 2.4% in April. The rise in May puts the March-May annualized growth rate at 5%-6%, the best 3-month period in the last two years.

And the improvements are not centred on just one or two segments, either. UBS notes the increase was broad-based, with most segments, barring food, enjoying a pickup in May. After falls in April, department stores and household goods were up around 1% from April, eating out was up about half a percentage point, while clothing increased by about 1.5%. Food was down a tad after being up in April.

The broker notes that all sub sectors are now up on a year on year basis. NSW leads the pack, with sales up 0.7% in May making for a 3.6% year on year growth rate, the state’s best performance in over a year. Queensland is also rising solidly, up 0.5% in May and 4.3% on a year on year basis, while Victoria and SA continue to lag the pack. WA remains the strongest, with sales up 1% from April and boasting a 10% growth rate year on year.

This all amounts to pretty good news, in the broker’s view, especially given the more traditional areas of retailing like department stores, clothing and household goods, what have been the weaker sub-sectors, are now showing clear improving trends. Thus, despite the few signs of an improvement in consumer sentiment, retail sales trends are none the less improving, leaving UBS to pencil in a full year retail sales improvement of 4%-5%.

One of the main economic supports Australia has enjoyed over the past few years has been the resilience of domestic housing prices. Where individual American and  European homeowners have seen their single largest investment asset depreciate mercilessly, worsening the effect of the economic downturn exponentially, Australians for the most part have escaped this pain, much to the benefit of national economic reads.

However, the assumed single largest factor supporting Australian housing prices, increasing demand, has been called into question by analysts at Morgan Stanley.

The broker notes that the long held belief that Australia suffers from – or enjoys, depending upon your perspective – a shortage of houses has been the cornerstone of the housing industry’s defence against significantly lower prices. The problem is, Morgan Stanley believes that current estimates of underlying demand are unrealistic and take little account of actual buying behaviour and in no way account for important factors like affordability and the willingness to leverage up.

Citing the 2011 Census data released a few weeks back, the broker notes the 228,000 unit undersupply that is estimated by industry is actually a 341,000 oversupply. The broker cites this as solid evidence of how easily estimates of intending to peg supply and demand can be manipulated and also fall victim to statistical errors.

The broker expects house price growth over the next decade will be meaningfully lower than in the past decade. The silver lining here is that the broker doesn’t expect to some sort of housing crash, but rather flat to negative growth over the medium term as wage growth outpaces price growth.

It is thus no wonder that Morgan Stanley has maintained its cautious outlook for the Australian housing market. It has the sector at Underweight and recommends staying away from names with significant residential exposure, including Stockland ((SGP)), Mirvac ((MGR)) and Australand ((ALZ)). 

Meanwhile, analysts at Credit Suisse took the red pen to their forecasts for the Australian insurance sector given the continued poor performance of investment markets. Insurance Australia Group ((IAG)) took the biggest hit; with FY12 earnings estimates cut by 11% on the back of the company’s significant exposure to equity markets in the short term, with FY13 down on lower bond yield assumptions.

QBE ((QBE)) was cut by lesser amounts, with lower investment market returns also joined by weaker AUD assumptions going forward. Suncorp ((SUN)) forecasts are also lowered on weaker investment returns, although it remains the broker’s top pick in the sector given the group’s ongoing recovery in its general insurance business combined with a strong capital position that should support the prospect of  potential capital management in the near term.

Morgan Stanley also took a look at Australian steel stocks last week, noting the big names in the sector have continued to underperform quite significantly over the past couple of months. There’s no surprise this has taken place at the same time that the last bits of appetite for risk dried up.

While the broker notes the downward moves in the sector have exposed some considerable upside to base case valuations, we all know valuation is little to go on in today’s market. Thus, the broker is still quite reluctant to shift to a more bullish stance on this basis alone, given it expects to see a continuation of the current challenges facing local manufacturing.

Morgan Stanley’s preference in the sector is Arrium ((ARI)), which up until a short time ago was called OneSteel. The broker notes earnings depend more on iron ore exports than steel manufacturing and the broker is fairly positive on the iron ore pricing outlook, believing iron ore pricing can be sustained at or above the marginal cost of Chinese production. 

Analysts at JP Morgan also see some support emerging for the bigger diversified resources plays. However, this support doesn’t come from normal drivers like better prices, lower costs or favourable FX, but rather from the capacity for the deployment of spare cash in the form of capital management initiatives. Such moves would be a sure way to offer shareholders a viable earnings alternative from longer dated production growth.

JPM sees a case for investor returns to hit 10%-12% were BHP Billiton ((BHP)) or Rio Tinto ((RIO)) to undertake share buybacks. Not a bad result when Olympic Dam only offers an 8% return on the broker’s numbers. However, the broker cautions that such relief won’t be forthcoming anytime soon, with neither BHP nor RIO likely to announce buybacks in August along with FY results.

While JPM expects capital management options will be discussed quite regularly in the lead up to and post FY results next month, it sees this as more of a medium term possibility. In the near term, the broker expects both companies will be more concerned about the slowdown in project approvals as growth pipelines are reviewed, with BHP also more likely to look at paying down debt and Rio wanting to keep its powder dry for potential strategic acquisitions.

Lastly, US analysts at Citi continue to hold a dim view of the 2H12 outlook for US consumer spending. The broker expects trends will continue to decline given the continued soft outlook for the global macro environment, ongoing weakness in Europe, declining consumer confidence and uncertainty about the looming presidential election.

Citi notes it first noticed the current slowdown emerging in April, when same-store sales missed forecasts for the first time since December. With trends having remained soft in May and June, the broker believes the slowdown is now being led by high-income consumers, who it points out make up around 50% of spending, own about 90% of US equities and thus take the biggest hits from investment market volatility.

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