Weekly Broker Wrap: Equities, Banks And Greyhounds

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-Oz equities remain attractive
-Selfies abandoning cash
-Bank performances polarise
-Bank upgrade cycle ending?
-More stringent greyhound rules?

By Eva Brocklehurst

Oz Strategy

After a stumble at the beginning of 2015, Australian equity markets have advanced strongly, spurred by the latest cut to the Reserve Bank’s cash rate. Citi notes the impetus has come from domestic investors responding to the low rates and adjusting their required return from equities. Foreign investors, too, are finding the market more attractive with the decline in the Australian dollar.

Citi does not believe a new paradigm is emerging. Since the GFC the perceived risk in equities has been heightened and equities have not closely reflected bond yields, until now. The broker suspects, as yields fall more and the GFC recedes into the background, the required returns from equities may edge down a little to below normal and reflect a return to the cycle.

Although wary of expecting the market to maintain a higher rating for equities, the broker suspects it could persist for a while as the economy continues to adjust to the end of the resources boom and rates stay low. The broker raises its target for the ASX200 to 6300 by end 2015.

Credit Suisse suggests the supply/demand situation for Australian equities is tight and there is more upside for index levels. Self managed super funds own 16% of the Australian equity market and their equity allocations are at 42%, but the cash allocation has declined to less than 28%. Lower rates suggest the cash component will come down further. The declining returns on cash raise the prospect of an income deficit.

Credit Suisse estimates that each 25 basis point rate reduction lowers the cash interest payments for these super funds by $500m. To maintain income levels they would need to switch $11bn out of cash and into equities. More dollars into the equity market will further support the dividend trade. Higher-than-median dividend yielders with better-than-median growth include Rio Tinto ((RIO)), Macquarie Group ((MQG)), Flight Centre ((FLT)) and Duluxgroup ((DLX)).

Bank Wrap

While bank revenues benefitted from the depreciation in the Australian dollar in the latest reporting season, Credit Suisse observes performances polarised in terms of financial markets income. Commonwealth Bank ((CBA)) and National Australia Bank ((NAB)) strengthened while Westpac ((WBC)) and ANZ Bank ((ANZ)) softened. System credit growth edged higher but customer repayment levels were again cited as a headwind to momentum. Net interest margins disappointed the broker, with intensifying asset price competition now outpacing fading funding cost advantages.

Cost growth also appears uncomfortably high relative to the revenue being generated, in Credit Suisse’s view. The broker notes risk weighted asset growth was high and the spectre of regulatory risks has re-surfaced. In this instance, Credit Suisse points to Westpac’s announcement regarding the treatment of mortgages, which underscores a need to not become complacent about regulatory capital.

The best days are behind the major banks, in Citi’s view. Investors need to be careful about what they construe but the broker highlights disclosures which reveal evidence that capital generation has peaked and revenue growth is slowing, as mortgage competition builds. Credit quality is improving but credit costs no longer drive the improvement in earnings. Citi now has all four majors on a Sell recommendation, reflecting a more challenging outlook and the strong rally in share prices as investors have unambiguously sought yield in a falling interest rate environment. The broker prefers the regionals, rating Bank of Queensland ((BOQ)) as Buy and Bendigo & Adelaide Bank ((BEN)) as Neutral.

Mining sector exposures make up less than 2% of the major banks’ loan portfolios. Morgan Stanley still suspects they could lead to a material increase in group loan losses from the “bottom of the cycle” levels. This is one reason why the broker suspects the earnings upgrade cycle has ended. Westpac highlighted in its first quarter update that stressed mining exposures had roughly doubled in the past nine months. Morgan Stanley notes ANZ has the largest relative mining exposure, with around 2.2% of total commitments, of which around 0.8% was non-performing in FY14.

ANZ’s loan portfolio has growth over he past two years, largely because of oil & gas lending which now accounts for 39% of the mining portfolio. ANZ also has exposure to metal ore, mining services and coal and the broker observes the portfolio is around 64% investment grade and the remainder sub-investment grade. Commonwealth Bank’s mining exposure is also weighted to oil & gas, with mining credit exposures at around 1.9% of total credit exposures. NAB has the least exposure to mining amongst its peers as a proportion of commitments, at around 1.0% of total.

Wagering

The greyhound industry has suspended thirty trainers, owners and stewards in the wake of the investigation into live baiting. While only several may be prosecuted, more stringent regulation may ensue and/or punters may forego betting on greyhounds. Credit Suisse believes a 5% decline in turnover would affect both Tatts‘ ((TTS)) and Tabcorp‘s ((TAH)) wagering earnings by less than 1.5%. Greyhound racing is around 12-15% of total wagering turnover but margins in this industry are low, as most turnover is through high-fee pari-mutuel betting.

Higher racefield fees are possible, should the industry need to counteract falling turnover or require funds for additional regulatory oversight. While still early days, the broker suspects the impact may be greater for Tabcorp than Tatts, as Tatts has most of its fees reimbursed by Queensland racing.
 

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