Weekly Broker Wrap: Exports, Jobs, Transport, Bank Credit And Retail

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-Export boom on the way?
-SMEs still critical to jobs growth
-Subdued growth weighs on transport
-Baby boomers affecting bank credit
-Durable goods retailer prospects better
 

By Eva Brocklehurst

What is the prognosis for Australia's economy? Will it manage to revive without relying on mining investment? These are the questions economists at Citi are asking. It's not just whether demand outside of mining will generate enough investment to offset mining's decline but whether the timing of the transition can be coordinated as well. If not, there's a substantial amount of volatility ahead.

Can the fall in mining capex and loss of income from a deterioration in the terms of trade be offset by enough strength in housing construction, non-mining business investment, consumer spending and net exports? Citi calculates that major project capex across coal, iron ore and gas is likely to halve which implies a fall in mining investment by 2018 of around 4% of GDP from the peak of 7.6% of GDP in FY13. Timing is uncertain, but Citi analysts suggest the fall could be most marked after FY15, as LNG projects are set to hold up the level of capex this year.  Unlike investment booms in other areas, the analysts note the mining boom produces a ramp-up in exports as the production phase gets underway. The Bureau of Resource and Energy Economics is the benchmark for exports forecasts and its data suggests that mining and energy exports will increase the contribution to GDP through to FY18, the bulk of the increase being in the next two to three years.

The cumulative drag on real GDP from mining investment is likely to be at the bureau's largest in the next two years. So, with declining investment broadly matched by a positive contribution from net exports, the real pace of growth is likely to be determined by non-mining domestic activity. Thanks to stimulatory monetary policy, Citi thinks there will be a sufficiently robust rally in housing and consumer spending to achieve growth close to trend in 2014-2016 and possibly enable growth to strengthen even more in later years, with the help of recovery in non-mining business investment and a lift in spending on infrastructure. Citi acknowledges this number crunching looks suspiciously stable, with GDP forecasts close to trend, but emphasises that growth is more stable already, in terms of the trade downturn, compared with previous cycles, because of better policy and institutional reforms. All in all, an investment boom being replaced by an export boom means that domestic demand does not need to do all the heavy lifting in rebalancing the economy.

Where will the jobs come from? That's what UBS asks. The analysts looked at the sectors of the economy which have created the recent improvement in the job market. Around 80% are in public-dominated sectors, with some gains in manufacturing, construction, finance and real estate which were countered by weakness in retail, accommodation and food. Most of the private sector jobs over the same period came from mining related areas, reflecting strength in professional, technical and scientific jobs. From analysis of the labour hire and job advertisement data, the broker identifies an ongoing reality that the majority of jobs are in small and medium-sized enterprises and this is where the growth is likely to come from. It's not from large business, where there tends to be highly publicised job losses that mislead in terms of the proportion of jobs being churned in the economy.

The public sector is not expected to contribute such a level of job improvement in the near term but a lower Australian dollar should benefit those sectors such as tourism education and domestic manufacturing, according to UBS. Manufacturing performance has already recovered a little and tourist arrivals have risen 8-9% over the past year. Relatively labour-intensive and interest-rate sensitive sectors of the economy – retail, wholesale trade and construction – are also likely to reveal a jobs recovery. The key sectors which could, in the current environment, plausibly contribute jobs include retail, wholesale trading, accommodation and food, construction and general services. Those most likely to be shedding jobs include manufacturing, mining and related areas.

Goldman Sachs has recently revised Australian dollar forecasts and incorporated this into assumptions about the transport sector. Factoring in a lower Australian dollar has meant downgrades for airlines – Qantas ((QAN)) and Virgin Australia ((VAH)) – and upgrades for US dollar reporting stocks such as Brambles (((BXB)) and Recall ((REC)). This is also broadly neutral for Asciano ((AIO)), Aurizon ((AZJ)) and Toll Holdings ((TOL)), which are more exposed to Asian currency movements. Domestic economic growth is expected to stay relatively subdued over the next 12 months. The analysts believe the non-mining economy will need to accelerate to 3.75% by the end of the year just to meet a 2.0% GDP growth forecast, given the drag from mining investment. This weak outlook is expected to weigh on volume in the domestic transport sector, particularly for Asciano and Toll. Asciano remains the broker's preferred pick for the sector. A transition to positive free cash flow in FY15 and progress on cost of capital should help drive a re-rating, in Goldman's view.

BA-Merrill Lynch observes the demographic that supported the growth of bank balance sheets for the 20 years to 2010 is fading. Unless banks can convince retirees to dramatically increase debt levels the broker thinks household credit will struggle to grow at anything beyond nominal GDP on a sustainable basis. Smaller consumer loan books suggest ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) are best placed to confront this structural challenge, although near-term business credit growth also appears cyclically weak.

The broker emphasises this is not the end of the housing rebound, rather that medium term growth will be slower and historical rates unlikely to be repeated. The broker also views the rise of investors in housing as a natural response to demographic change, although this contributed to a substantial rise in household gearing. As the pre-retirement 45-64 age group increased so did investor housing and overall debt. Now this demographic is approaching retirement and recent data suggests the 55-plus group reduced gearing from 2010-12. While Westpac's ((WBC)) greater investor mortgage exposure offers some appeal near term, Merrills thinks it is unlikely to offer substantial upside relative to peers.

Retailers have had mixed fortunes recently, with several finding it hard to balance top line growth with margin preservation. Either way, Merrills thinks the household/durable goods retailers have better growth prospects than department stores and apparel merchants. Why does the broker like the former? First there's industry consolidation. In the last three years store numbers outside of the three majors – JB Hi-Fi ((JBH)), Dick Smith Holdings ((DSH)) and Harvey Norman ((HVN)) have declined by 33% which provides a more favourable market dynamic for the majors. The broker also believes household goods face less competition from online than soft goods and the penetration of online sales will begin to plateau at levels below other developed countries. The level of store saturation in Australia in consumer electronics and appliances is behind global peers and this supports continued store roll out, to some extent, Merrills adds. The preferred stock is JB Hi-Fi , which the broker thinks has the ability to grow earnings by over 35% in the next three years, self-fund capex and maintain a dividend pay-out ratio of 60-65%.
 

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