Weekly Reports | Apr 08 2013
-Retail sales turn higher
-But does the sector have staying power?
-Population growth should help
-But house construction is lagging
-And bank outlook overly relying on mortgages
By Eva Brocklehurst
Don't rush out for that bottle of champagne to toast the return of the big spender, market analysts warn. Retail sales jumped in February, by 1.3%, the latest figures from the Australian Bureau of Statistics show. January retail sales were revised higher, now seen up 1.2% against 0.9% originally published. Nevertheless, an ongoing recovery is needed to embed a return to trend growth. Also, in the case of the retailers listed on the stockmarket, there's more than just a subdued consumer providing headwinds.
Citi notes expectations are pretty strong for improving retail sales over the next six months, if Australian discretionary retail shares are a guide. These stocks have risen 28-47% over 2013 in anticipation of a return to better times. If this spending spike does eventuat, there could be upgrades of as much as 28% to consensus earnings forecasts and furniture and home improvement retailer, Harvey Norman ((HVN)), has the greatest upside potential, in Citi's opinion.
What Citi suspects is that, without further interest rate cuts, any stimulus to spending will soon fade and retailer sales and earnings are then likely to subside. The broker concedes that a 3% spike in retail sales is possible over the next six months but notes that the weak link here is house prices. Lower interest rates have resulted in a rise in house prices. While this may increase consumer perceptions of how well off they are, and invigorate retail spending, the broker would not be relying on it. A retail sales spike has occurred in past rate-cutting cycles, but buying the retail cycle on the basis of interest rate stimulus is dangerous, Citi maintains. Usually there is a "hangover" the following year.
Citi is bearish on a 12-month view and has Sell ratings on all large discretionary retailers, because a rally in retail stocks is likely to be short-lived if the driver is only a short-term spike in retail sales. The analysts note fundamentals remain very challenging, particularly given stores need to close, barriers to entry are reduced and gross margins are already at record levels.
Macquarie is also cool about recent strength in retail sales. The analysts doubt consumers have suddenly dropped their guard and become big spenders again. Macquarie notes retail trade accelerated at about trend, around 3.5-4%, in the first half of 2012 as the government put carbon tax compensation payments in pockets. Then, confronted by higher electricity bills later in the year, retail spending fell back. Despite the recovery in spending at the start of this year, Macquarie notes the level of sales is still below the trend pace of the past 18 months. This suggests that there could be more upside for retail sales in the next few months but doesn't necessarily mean that the underlying trend pace of spending will improve markedly.
One area which may help keep retail sales bubbling along is the population increase. UBS economists noted a significant slowing in spending per person after the 2008 global financial crisis. The slowing in population growth at that time would have accentuated the impact on the domestic economy. Now, with population growth accelerating and some modest recovery in consumer spending, the outlook for 2013 is for a further improvement in retail sales. Australia's population growth was 1.7% over the year to September 2012, official figures show, the highest since September 2009. UBS thinks retail growth will veer towards 4-5% from its current 3% pace.
Net overseas migration was the major contributor to the population growth and people are also going where the jobs are. Population growth continues to be strongest in the mining states of Western Australia and Queensland, followed by Northern Territory. Australia’s relatively firm population growth of the past eight years has been driven mainly by a doubling in net migration and migrants see the strong job market as the attraction, according to Commonwealth Bank economists. Jobs growth is averaging 2% per annum in Australia, in sharp contrast to many OECD economies. It's not only jobs people need but housing. The return of a relatively rapid pace of population growth is a positive for the economy and UBS economists believe it should underpin moderately better consumer spending, while also contributing positively to housing demand.
The problems is the lift in the population has occurred against a backdrop of only modest new dwelling construction. From the Commonwealth Bank economists' viewpoint, new dwelling construction will be close to the 160,000 level in 2013 but still below underlying demand of around 170,000. The net result of this will be upward pressure on national rents. Aside from the need to house more people, the major demographic issue for Australia is its ageing population which will drive an increasing demand for health care and change the balance in types of residential accommodation required by residents. The proportion of the Australian population over 65 years of age was 13.5% in 2010 and is expected to be 15.3% in 2015.
Macquarie analysts also find the disconnect between improved sentiment and real economic data most apparent within the housing sector. While some investors are convinced that housing has turned and activity will boom, Macquarie is not so sure, highlighting the the lack of uniformity between types of dwelling and the states which have inflated headline readings. For instance, Victoria stands out in terms of a surge in medium density approvals. The analysts note medium density approvals have far outweighed activity in the more important detached housing segment. This may be attributed to increased investor demand, particularly from offshore, and a structural shift away from standalone houses.
Either way, Deutsche Bank analysts questioned how effective the cuts to the cash rate have been for increasing mortgage lending. Historically this had a strong correlation with a lag around 12 months. Therefore, a rebound in housing growth should be on the cards in FY13. High household debt levels may limit the rebound, while the financial benefit to bank profitability from housing growth is small, in reality. Bank share prices are around record highs and suggest the market is factoring in earnings upgrades but this needs to come from broader based lending recovery, Deutsche Bank maintains.
Their analysis suggests 100 basis points of cash rate reductions has previously, on average, equated to a 1.9 percentage point increase in housing lending growth. Given the 125 points in cuts that was delivered over the last 12 months, this would suggest a 2.0-2.5% increase in housing lending growth over FY13. The low margin earned on mortgages these days and limited non-interest income indicates that every 1% increase in housing lending now would only lead to around a 0.4% increase in profits. As such, the 2.0%-2.5% increase in growth implied by cash rate reductions to date could only lead to additional profit growth of around 1% for the banks.
High housing leverage makes rapid mortgage growth unlikely. The analysts think 8-9% housing loan growth is unlikely given the elevated level of household indebtedness. Affordability may improve with lower lending rates but households appear to be sufficiently uncertain about the economy and employment that the leverage to cash rate reductions may prove to be weaker than previously. There's another factor at play now too. Out-of-cycle mortgage re-pricing has partly offset cash rate reductions. Increases to the standard variable rate from the major banks have also likely had an impact on dampening mortgage growth. The cash rate has fallen by 125bps over the past 12 months and housing standard variable rates have fallen by only 85-90bps.
Turing to national stock market performances, after all this musing about whether some sectors are ahead of themselves, we note Citi has ranked countries by stock market performances in March. In spite of the Cyprus issue, global markets were stronger, with the MSCI world benchmark edging up 1.9%. Topping the Citi favourites is South Korea. The broker's model underperformed the benchmark by 2.8%, attributed to a weak outcome in South Korea, which Citi still likes, and outperformance in Mexico, which Citi finds unattractive. Canada is ranked second in attractiveness followed by Australia. Belgium and Germany are fourth and fifth respectively. At the bottom? The Cyprus spotlight has put Italy and Spain back at the bottom of the scale, just above Mexico. With Malaysia and Brazil, this rounds out the five the broker finds least attractive.
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