Weekly Broker Wrap: Oz Insurers, Budget, Supermarkets, Banks And Aged Care

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–Capital management potential in insurers
-Budget: tax cuts unlikely, super changes possible
-Aldi can further close gap to majors
-Major bank re-pricing likely after election
-UBS envisages no sharp rise in bad debts
-Brokers: aged care proposals broadly positive
 

By Eva Brocklehurst

General Insurers

Conditions are ripe for capital management and risk management in the general insurance industry, Macquarie contends. Current valuations of Suncorp ((SUN)), Insurance Australia Group ((IAG)) and QBE Insurance ((QBE)) capture the excess capital, although the broker only includes capital management on a one-year forward basis.

Despite a positive view on the potential for capital management, which supports a combination of special dividends, buy-backs and/or share consolidation, the broker continues to forecast difficult operating conditions, with low growth and margin pressure.

Morgan Stanley considers the outlook is tough for insurers. Returns on equity exceeding the cost of capital and negative real rates attracting capital are the main headwinds.

Global re-insurer returns are falling, although profitable at around 10%. The broker observes soft re-insurance pricing is flowing through to weaker global pricing by primary insurers.

The broker prefers exposure to strong domestic franchises such as IAG and speciality business which is relatively more resilient, such as QBE.

Budget Preview

The Commonwealth deficit is tracking broadly in line with the Mid Year Economic and Financial Outlook (MYEFO) released in December, and UBS observes the 2016 budget could be the first in a number of years with minimal fiscal slip.

Supporting this is a surprise lift in iron ore prices, which could add up to a cumulative boost of $27bn over four years. Still, UBS expects some offset in stalled savings from prior budgets and the trimming of nominal GDP forecasts.

Monthly data is showing a cumulative financial year-to-date deficit of $39bn. The broker notes changes to GST and housing have been ruled out. Modest personal income tax cuts are possible but a company tax cut appears to have been delayed.

Changes to superannuation seem likely, with the broker suspecting a lower threshold at which contributions are taxed at 30%. The possibility of a large rise in government infrastructure spending, probably funded by long-term bonds, is on the cards and to some extent priced in by the market.

The broker considers the budget could be an opportunity to buy into attractive long-end Australian government bond valuations.

Australian Supermarkets

The reason for Aldi's success, on Morgan Stanley's analysis, is that customers start out buying staples — products with a low risk of failure — and after these have met expectations purchase more products, moving into other dry grocery lines. From there consumers graduate to fresh food.

Aldi's prices are around 25% cheaper on "like" products the broker compares with Coles ((WES)) and Woolworths ((WOW)) , where consumers spend $220 and $228 respectively on average over a four week period.

So it is clear that in terms of basket size, Aldi will not catch up. However, Morgan Stanley does believe Aldi can close the gap. Aldi has increased its basket size by 67% since 2007, but customers spend just $100 over a four week period.

Morgan Stanley forecasts a potential penetration for Aldi of 10% of the Australian food and liquor market by 2020.

Australian Banks

Despite the near-term pressures, Morgan Stanley expects future re-pricing initiatives from the major banks, in the wake of Bank of Queensland's ((BOQ)) move to raise variable mortgage rates, will be delayed until after the federal election.

The broker expects more emphasis on risk-based pricing for home loans, with potential for further differentiation in pricing for investors, interest-only loans and offset accounts.

Morgan Stanley notes 51% of National Australia Bank's ((NAB)) book is now Australian home loans and it receives as much benefit as Commonwealth Bank ((CBA)) and Westpac ((WBC)) from standard variable rate re-pricing. ANZ Bank ((ANZ)) receives the least benefit, given its business and geographic mix.

A number of specific problem exposures in the corporate sector have caused renewed concerns from investors regarding the banking sector, UBS observes. The broker's research indicates that investors are unsure whether this is the start of a more significant bad debt cycle or relatively isolated spikes in the trend, principally caused by limited fall out from the end of the resources boom.

The broker does not that at the same time recent macro economic data has surprised to the upside, with strong business conditions and low unemployment. A low and stable cash rate is not consistent with a marked deterioration in bad debts, the broker observes. On that basis UBS believes bank valuations remain attractive.

GUD Holdings vs GWA Group

Both GUD Holdings ((GUD)) and GWA Group ((GWA)) have strong domestic brands and well recognised household names, while UBS observes consistent high margins have been part of their respective portfolios – automotive for GUD and kitchens & bathrooms for GWA.

Yet while the stocks screen cheap they are not without issues, the broker contends. Top line growth has been sluggish recently and the companies have shifted away form domestic manufacturing to pure import models which means a high level of exposure to movements in the Australian dollar.

Each has undertaken significant restructuring to remove under-performing parts of their portfolios. UBS is positive on GUD, with a Buy rating, given the higher proportion of earnings from automotive after the BWI acquisition and the recent sale of the remaining stake in Sunbeam.

UBS believes lacklustre top line growth and FX pressure, with poor cash conversion and top heavy corporate structure, means GWA has issues to address. Hence, a Neutral rating is retained.

Aged Care

The Aged Care Sector Committee, which provides advice to government, has released a guide to future reforms. The fact that this has been done in close proximity to an election signals to UBS that the government partially endorses the proposals.

The theme is increasing choice and control for the consumer, which the broker suspects will ultimately favour large, well managed, residential aged care operators. The guide recommends a removal of the distinction between care at home and residential care.

Major recommendations include reduced controls on the supply of beds, transparent performance standards, and a review of current funding with the intent to make new financial products available.

For the listed providers Deutsche bank believes a deregulated environment would be broadly positive but the wide ranging proposals introduce a number of new risks which are difficult to quantify. Nevertheless, the providers are expected to have sufficient time to adjust to any changes and the broker awaits the government's response before reviewing forecasts.
 

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