Weekly Broker Wrap: Australian Dollar, Supermarket Suppliers And Banks

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-Trade not influencing AUD value
-Official rate cut factored into AUD
-Woolworths struggling to improve sales
-Macquarie views ANZ returns sustainable
 

By Eva Brocklehurst

Australian Dollar

ANZ researchers have found little evidence that changes in Australia's trade composition have influenced the currency or the size of its risk premium. The analysts note the Australian dollar has been persistently overvalued relative to traditional commodity price models since 2010. The overvaluation was most extreme between 2010-13, which reflected foreign buying of Australian bonds because of relatively high rate spread differentials and absolute yields.

This came about at a time when the composition of Australian trade was evolving, with less reliance on cyclical resource exports. Services exports have risen sharply as a proportion of trade recently although these remain within historical ranges.

The analysis signals changes in Australian dollar valuations drive changes in the services balance but there is no converse link – changes in services do not drive the Australian dollar. The changing composition of trade cannot be responsible for the Australian dollar's resilience, the analysts maintain.

Rather, they continue to believe the persistent overvaluing of the Australian dollar reflects a heightened focus on sovereign rates in this cycle, rather than changes in the trade structure or broader vulnerabilities in the economy.

St.George analysts note risks to the outlook are broadly balanced and the Australian dollar is likely to trade within the mid US70c range for the remainder of the year. The analysts expect the Reserve Bank of Australia will reduce official interest rates again, observing this is largely factored into markets and the currency.

Downward pressure from a decision to reduce rates will be limited, in the analysts' view, given the easy monetary stances from other major central banks. While the US Federal Reserve may still rates rates this year the likelihood in the near term has lessened. Commodity prices are also unlikely to rally substantially, the analysts believe, given the modest pace of global growth. This underpins the view the currency will not trade far from the mid US70c range.

Strategy

The financial year has finished fairly flat for Australian equities, with the ASX200 index down 4.1% in FY16. Including dividends, the total return of the index was up 0.6%. UBS notes the fall in the return on the index was driven by a fall in earnings expectations offset by a small price/earnings multiple re-rating.

In terms of sectors, banks and resources underperformed and industrials outperformed, notably the yield sectors such as infrastructure, Australian Real Estate Investment Trusts (A-REITs) and utilities. Mega cap stocks underperformed while small-mid caps outperformed. UBS remains Underweight on mining, A-REITs and consumer staples, Neutral on energy and Overweight banks. The broker continues to have exposure to US dollar earnings and domestic cyclicals.

Supermarket Suppliers

For the first time in the UBS supermarket survey, Coles ((WES)) leads Woolworths ((WOW)) in all 26 sub categories. There were signs of better execution in areas such as fresh offerings and marketing and Woolworths is closing the gap to Coles. Yet, the survey found poor and deteriorating in-store compliance and internal culture are hurting the ability of Woolworths to translate its price investments into improving sales.

The risk of a price war grows, with suppliers forecasting shelf price deflation for the next 12 months. Suppliers were critical of marketing and in-store theatre and suggest Coles may need to invest more in operations going forward. Woolworths' average relative survey score did not improve, which suggests Coles will maintain its lead over the first half of FY17. Nevertheless, there are signs Woolworths is bottoming and UBS believes this could trigger increased investment from Coles to ensure top line momentum is maintained in a slowing market.

UBS expects Woolworths to still narrow the gap to Coles in the first half but acknowledges the survey does signal forecasts may prove optimistic. Thus a Sell rating is reiterated for Woolworths with a Neutral rating and negative bias for Wesfarmers.

Banks

The Australian Prudential Regulatory Authority has updated on the capital position of the major banks. The regulator believes, while the banks are in the top quartile of internationally active banks with an average CET1 ratio of 13.5%, the level of capital will need to continue increasing.

ANZ Bank ((ANZ)) is the only bank in Macquarie's view that should sustain its returns over the next three years, while the returns of peers are expected to decline by 11%. Forecasts currently incorporate $19-20bn of additional capital across the majors by 2019.

The broker continues to believe that in a low-growth environment, banks should be able to organically generate capital and maintain elevated pay-out ratios. Macquarie recognises some risk of further capital raising if banks are not prudent in capital management, if balance sheet growth exceeds expectations and/or if banks are reluctant to lower pay-out ratios.

Macquarie remains slightly Overweight the sector based on its relative yield attraction and expects share price weakness in the near term should political uncertainty continue.
 

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