Weekly Broker Wrap: RBA Easing Not Over; US Economy And Oz Utilities

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-Still expecting RBA rate cuts
-RBNZ likely to hike
-US growth accelerates
-Electricity churn eases
-Merrills upgrades APA
 

By Eva Brocklehurst

The Reserve Bank of Australia may have left the cash rate unchanged, as expected, after last Tuesday's meeting but several brokers warn it's not a case for yawning. Goldman Sachs observes the central bank is a little more upbeat in assessing recent economic trends and the statement accompanying the decision shows the central bank is shifting focus. The statement incorporated a sense that the RBA has taken the first small step towards a more neutral setting, from a highly accommodative one.

So, is the easing cycle done for? The broker thinks not. Ultimately, inflation is low, demand is tepid and employment is contracting. For the broker, a lack of demand is the key risk, not inflation. The latest increase in inflation does complicate the issue regarding whether further official rate cuts are on the cards, so Goldman's forecast changes have been pushed out to July. A cut to the cash rate is still forecast. The commencement of the tightening cycle, in the broker's forecasts, has been also pushed out to the second quarter of 2015.

Goldman thinks there's headwinds to GDP growth this year, with delays and cost blow-outs at key LNG projects, completion of construction at several iron ore mines and a likely surge in public infrastructure spending. Exports are still expected to be robust but the contribution could be more modest. This will keep the focus on the pace of recovery in the non-mining economy and there is a risk that a return to above-trend GDP growth will be delayed well into 2016. This adds up to downward pressure on the cash rate, in the broker's opinion.

A shift in the RBA's assumed bias is apparent to BA-Merrill Lynch as well. The broker considers, despite the more positive stance, that downside risks to the economy remain in place. The unemployment rate is expected to rise on a sustained basis and mining investment is forecast to be detracting consistently from growth in the second half of 2014. The broker anticipates the non-mining sectors will not recover to the extent needed to offset the mining decline. The broker suspects the rise in inflation is temporary and expects a rate cut in the second half of the year, settling for August as the key date.

Across the Tasman the story is about the Reserve Bank of New Zealand's nervy trigger finger. Alliance Bernstein suspects, while there was no action this week, the RBNZ will counter a combination of strong growth and rising inflation with an official rate hike in March. The RBNZ governor signalled rates would not be staying at current levels for much longer, which effectively signals the central bank is about to move. The broker notes there's 100 basis points of rate hikes by September factored into the market and a further 50 basis points by mid 2015. The justification is clear. NZ GDP is running at 3.5%, above trend, and inflation has surprised on the upside.

What about the US economic trajectory? Growth has shown improvement in the latter half of 2013, with real GDP growth estimated to be 3.2% annualised in the fourth quarter. Alliance Bernstein finds many signs the US economy is turning a corner, with a large boost to growth from consumer spending in the December quarter. Big ticket items have been impressive, with durable goods spending up 5.9% in the quarter. The broker believe the spending on equipment and software, which rose 6.9% in the quarter, also signals an economy that's looking stronger. Construction activity indicators are pointing to double digit gains for commercial construction in 2014. The drag from the federal sector is also waning as Congress recently passed legislation that postpones sequestration cuts for the next two years. Alliance Bernstein suspects there's a real chance GDP growth could expect current expectations this year.

Churn rates in Australia's electricity market slipped in January and this represents the third consecutive month of decline, according to JP Morgan. This has been largely underpinned by the cessation of door knocking by the big three retailers. South Australia bucked the trend and recorded an 0.8% increase in transfer activity. In contrast, churn rates for gas increased in January, with the exception of Victoria. Churn rates rose to 14.9% from 12.5% in South Australia, the largest increase. The broker envisages a number of factors coming to bear on the electricity market which should bring some relief to retailers. Besides the cessation of door knocking there's de-regulation in SA and Queensland and the potential for a similar move in NSW. The broker thinks there is sufficient evidence that the competitive intensity is cooling, particularly in Victoria and Queensland which is supportive for AGL Energy ((AGK)) and Origin Energy ((ORG)).

Merrills has reviewed the Australian regulated utilities sector and is more comfortable with the growth profile of APA ((APA)), upgrading the stock to Neutral from Underperform. Cash returns from assets have increased and the company's track record is solid in the broker's view. The key headwinds are higher gas prices and a risk that Queensland/Cooper gas from the Moomba Sydney pipeline will be diverted to Gladstone for LNG. While lower southbound throughput is a risk, the broker believes concerns from this quarter are somewhat overplayed.

On the downgrade front, the broker has lowered the rating on SP AusNet ((SPN)) to Underperform from Neutral, noting lower total returns compared with peers. The broker acknowledges that the company has capacity to be more aggressive with distribution policy but, with no signal that's about to change, Merrills' top preference is with the likes of DUET ((DUE)), a stock that stands out in terms of the yield premium that's on offer.
 

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