Weekly Reports | Aug 25 2017
This story features INTEGRATED RESEARCH LIMITED.
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Weekly Broker Wrap: LNG; banks; political risk; Integrated Research; Skydive the Beach; super funds; and market volatility.
-In value terms, LNG exports expected to overtake coking coal early in 2018
-Bank income softens, net interest margins strengthen and bad debts remain modest
-Lack of political zeal for productivity-enhancing reforms the real issue facing Australia's Parliament
-Not-for-profit super funds continue to outperform by a strong margin
-When volatility returns, forced selling of risky assets could amplify equity market correction
By Eva Brocklehurst
LNG
The investment phase in LNG in Australia is coming to the end. Three large Queensland projects are completed and the construction of the largest project in Western Australia, Gorgon, has recently finished. This leaves just Wheatstone in WA, Ichthys in Northern Territory and the floating facility, Prelude, off the coast of WA to go. Commonwealth Bank analysts expect the latter three will be up and running in 2018.
Meanwhile, the production phase of the LNG boom is already underway and affecting the economy by boosting growth, largely showing up in GDP as exports. In terms of employment the production phase does not require as much labour as investment phase and there has already been a decline in oil & gas employment as projects have been completed, the analysts observe.
LNG exports are expected to lift by around 24% in 2017/18 and by 16% in 2018/19. In value terms, LNG exports are expected to overtake coking coal early in 2018. The value will be affected by the price prevailing at the time but according to Department of Industry forecasts, higher LNG export value should add an extra $740m to the monthly trade balance in 2017/18 and a further $550m in 2018/19.
The export of LNG has implications for domestic gas and electricity prices in the eastern states, increasing the linkage between international and domestic prices. The analysts suggest the linkage is likely to remain strong as all three of Queensland's LNG projects can choose to supply domestic or international markets.
The share of household spending on electricity and gas rose steadily between 2007 and 2014 and, as prices rose, households responded by cutting the amount of electricity and gas they use.
Still, the analysts note, there is a limit to how much further volumes can be reduced and this is unlikely to be enough to offset the latest jump in prices. With household balance sheets stretched and wages growth weak, this suggests many households will have to reduce spending on discretionary items.
Banks
Credit Suisse observes financial market income softened over FY17 from its first half cycle peak, although net interest margins generally strengthened. Listed banks are reported to be in the process of meeting macro prudential lending requirements, while lenders outside of the majors are hitting processing capacity constraints as increased mortgage applications are being received.
The broker suspects de-leveraging of the resources sector may have finally run its course. Customer margins expanded in the latest reporting season, driven by deposit and wholesale funding spreads as well as asset re-pricing. However September quarter margins for the majors will include the inaugural bank levy accrual.
Less positively, business lending spreads are under competitive pressure and endowment margins are compressing. The broker welcomes the fact the banks at least talking about accelerating productivity programs.
Meanwhile bad debts remain very modest and, within the household sector, mortgage & consumer delinquencies have reduced seasonally. Credit Suisse forecasts major bank average earnings per share growth of 3%, including bad debt charges rising only very modestly, to 0.21% in FY19 from 0.18% in FY17.
Political Risk
Deutsche Bank believes broader points are being lost in the citizenship argument that is currently facing a number of senators and at least one member of the House of Representatives in Australia. Namely, governments with very small majorities are typically prone to volatility and this makes delivery of true productivity enhancing reform more difficult.
So, for Deutsche Bank, while the dual citizenship debacle makes for interesting copy, the crisis really doesn't make Australia any more prone to political risk than it has been since the outcome of the July election in 2016. The citizenship issue is simply a symptom.
An underlying issue is the tightness of the number of recent elections, the short tenure of Prime Ministers since 2017, and the lack of support for serious productivity-enhancing reform. In many instances, past achievements have been unwound as a cost of keeping minor parties and cross-benchers happy. This, the analysts suggest, conspires to further entrench the productivity malaise and keep wages growth weak.
Integrated Research
Integrated Research ((IRI)), a global provider of performance management software, posted a strong 62% increase in operating cash flow in FY17, which Bell Potter observes came despite this being the third and final year of supposedly weak cash flow, because of a transition to annual licence fees rather than upfront payments.
On the negative side Unified Communications only grew by 1%, as some Avaya customers delayed purchases because of Avaya's Chapter 11 status. Bell Potter maintains a Buy rating and $4.00 target.
Skydive the Beach
Skydive the Beach ((SKB)) posted a strong FY17 result, beating guidance despite adverse weather conditions. Canaccord Genuity notes there was a strong increase in bookings, improved margins as a result of efficiency gains and diversification outside the core business.
The outlook is positive and the broker continues to like the stock for exposure to the inbound tourism thematic and the likelihood of further accretive acquisitions. FY18 is also expected to benefit from a full year contribution from the acquisitions of Raging Thunder and Reef Magic Cruises, which have delivered ahead of expectations. Canaccord Genuity retains a Buy rating and $0.80 target.
Super Funds
Not-for-profit industry superannuation funds continue to outperform bank-owned retail funds by a widening margin, analysis by the Australian Prudential Regulation Authority to June 2017 has revealed. Industry Super chief executive, David Whiteley, described the performance as alarming.
He said the average income earner may experience a 2% difference in performance, which equates to a difference of around $200,000 at retirement, calculated from a starting age of 27, a retirement age of 67 and an income of $80,000 per annum.
Mr Whiteley said policy makers that are serious about strengthening the retirement income system should look at cross-selling, profit flows and performance within the vertically-integrated financial institutions.
Volatility
Portfolio managers at Hexavest believe investor complacency and popular bets against the CBOE volatility index (VIX) are some of the reasons why markets may experience more turbulence following a prolonged lull, and why a cautious stance is warranted now.
The VIX index is a measure of market expectations of near-term volatility. Shorting the index has become a very crowded trade, the researchers suggest, perhaps because of the increased popularity of exchange-traded products that are linked to the index. At some point any further spike in market volatility could be exacerbated by the unwinding of these short positions.
Central banks have contributed to reduced volatility in markets, through lower interest rates and massive asset purchases. Hence, many investors perceive central banks as a backstop for markets, leading to excessive risk-taking. If central banks contributed to the decline in volatility with their bond purchases over the last few years volatility should increase if their unconventional monetary policies are unwound.
The researchers believe, when volatility comes back, forced selling of risky assets could significantly amplify any equity market correction. Hence, a more defensive stance, higher levels of cash and a focus on preserving capital are justified, as the risk of a market correction is high.
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