Weekly Broker Wrap: Oz House Prices, Building, Confidence Are All Subdued

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-Low rates, house prices underperform
-Questions over building activity recovery
-Goldman Sachs sees subdued Aust growth
-$A fall gives banks funding flexibility
 

By Eva Brocklehurst

You'd expect low mortgage rates would be driving gains in house prices but they're not. This is unusual if the period since 2000 in Australia is anything to go by. Since the Reserve Bank started reducing the cash rate in October 2011, house price are actually slightly lower as of May this year. While auction clearance rates have been rising over the two year period and usually coincide with rising house prices, this time they don't.

BA-Merrill Lynch economists note auction results really only reveal buyer and vendor expectations, not the direction of prices. At present, vendors are likely to be less bullish about getting price premiums and buyers are looking for bargains. Consumer confidence is viewed as subdued over the remainder of 2013 with house price growth flat to up just 5%. The fair-value estimate of house prices suggests that the current level of prices is 7.6% below where it could be if households were prepared to borrow at their long-term average propensity. Hence, the underperformance of house prices can be linked to a lack of confidence, amid concerns about unemployment. 

In June, the unemployment expectations index, in the Westpac/MI consumer confidence survey, rose sharply to levels not seen since the steep economic downturn in 2008/09. Thus despite the fact that now is a good time to buy a house, a lack of confidence prevents many from embarking on that journey. The lack of house price growth has also been holding back the residential construction cycle. This is despite very low mortgage interest rates.

Potential property market participants remain cautious as prices are not rising consistently so there is no urgency to enter the market to buy a new home. Thee economists find this is particularly true of first home buyers of detached, newly-built homes. These are usually constructed in outer or developing suburbs that are particularly susceptible to falling house prices when the market weakens. BA-Merrill Lynch does not believe the Reserve Bank is concerned about house prices at this point but a sharper run-up in prices down the track may change that.

Citi thinks it's just a matter of more time until this easing cycle's 200 basis points of official rate cuts filters through to housing market sentiment but the housing supply is viewed as constrained because of tougher lending credit conditions. Building activity has been notably mixed this year, with early signs of stability approvals, amid weakness in commercial construction and a slowdown in engineering construction. The question is as to whether any pick-up in construction is sufficient to offset weakness in resource-related activity. Residential building approvals remain positive because of interest rate reductions but do require stronger reforms for sustainable growth, in Citi's view. Meanwhile, the slowdown in public construction by the federal government has dampened overall activity.

The broker has reduced its recommendation on Adelaide Brighton ((ABC)) from Buy to Neutral following guidance from ABC management that profit would be similar to or less than FY12. Slowing residential and non-residential activity offsetting growth in the mining and engineering sectors. The broker is also cautious about recent improvements in the stock price of GWA Group ((GWA)) due to it being a late-cycle construction stock and there being no material sustainable upturn in leading indicators. Citi rates GWA as a Sell. Sell recommendations are also held for Fletcher Building ((FBU)), Boral ((BLD)), James Hardie ((JHX)) and CSR ((CSR)). Fletcher has the highest expected total return amongst this group, and as consequence is relatively preferred.

In engineering construction the fall in commodity prices and rising costs have brought forward the peak in resource capex to 2013. This, combined with Citi's general expectations of declining capex over FY14-15 is making earnings growth challenging for the sector. The preferred pick in engineering and construction is Downer EDI ((DOW)). Buy ratings are also held for Hill Industries ((HIL)) and Stockland ((SGP)).

Goldman Sachs has incorporated softer domestic economic activity and a lower Australian dollar in a review of the steel sector. Australian economic growth is lowered to 2.0% from 2.4% for 2013 and to 1.9% from 2.7% for 2014. The Australian dollar forecasts have been revised to US90c from US93c for FY14. There is upside seen for BlueScope ((BSL)) on a lower Australian dollar, stronger-than-expected demand recovery and higher steel making spreads. Sims Metal Management ((SGM)) has downside risks from scrap demand, pricing and margins and a higher Australian dollar.

The domestic chemicals sector was mostly unchanged in the week to July 1. Goldman notes specifically that Nufarm ((NUF)) was up 0.67% while Incitec Pivot ((IPL)) was down 1.07% on limited stock-specific news. Orica ((ORI)) declined 0.75% in a week when the chief financial officer announced his resignation. Di-ammonium phosphate (DAP) pricing was largely unchanged, down US$1/mt to US$478mt (FOB) in the week to June 13. DAP pricing has fallen below Goldman Sachs' FY13 assumption for Incitec Pivot of US$520/mt.

The recent depreciation of the Australian dollar has driven JP Morgan to take a look at bank earnings and funding, concluding that the biggest near-term positive is funding flexibility from increased collateral pools on cross currency swaps. The analysts think the banks need to look at how much of the currency's move is structural, prior to re-deploying funds to enhance yields. The biggest longer-term positive is offshore wholesale funding capacity. For a given level of Australian dollar-equivalent wholesale debt, banks can now issue less into offshore jurisdictions.

One of the potential longer-term negatives is that outflows from foreigner sales of investments in local bonds and equities may result in lower deposit growth, as funding leaks from the system. The resulting fall in the currency will have the offsetting benefits of increasing collateral again in the short term and increasing offshore wholesale funding capacity in the longer term to plug the gap. JP Morgan finds translation benefits do not have a significant impact on earnings, with the hedging of foreign currency operations resulting in a lagged benefit at best.
 

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