The Wrap: Banks, Childcare & Gold

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

Banks will find it difficult to portray a true picture of their performance; market not yet pricing in A$ risks for companies with offshore exposure; continued support to childcare to help operators survive the pandemic.

-Bank: Don't expect a lot of clarity in this reporting season
-Childcare support in Victoria to help operators survive
-The rising AUD does not bode well for offshore earners
-Gold prices at risk of a sharp correction

By Angelique Thakur

To pay, or not to pay, that is the question

The current macro-economic backdrop looks very far from the jubilation felt in May when it looked like the economy was well on its way to recovery. The happiness was short-lived, till early June to be precise. 

With covid-19 raising its ugly head once again and Melbourne going under Stage 4 lockdown, the recovery is at risk. In all of this, banks have taken a severe beating from the continuous decline in economic and lending activity.

The deferment of loan loss recognition will lead to low recognition of impaired loans. Citi feels banks will find it difficult to provide a true picture of their performance this reporting season. 

While lending has lagged, deposit growth has been strong and Citi thinks the banks will use the build-up to repay their long term wholesale debt. Citi predicts higher than consensus net interest margins (NIM) for FY21.

The broker suggests loan loss provisioning, forward statements on revenue and net interest margins will be the focus this season.

UBS expects lower credit impairment charges given limited new non-performing loan formation as a result of loan deferrals. However banks are likely to be rewarded for provisioning prudence in this environment.

APRA's latest clarification suggesting major banks can pay deferred first-half dividends raises the question of whether it would make any sense to do so.

One of APRA’s instructions to the banks is to keep the payout ratio up to 50% but offset this with capital raising. UBS considers this a futile exercise that will do nothing except create an artificial dividend while diluting investors’ holdings.

UBS notes every bank, with the exception of the Commonwealth Bank ((CBA)), is trading below book value. The broker notes dividends are not an annuity, a statement that holds especially true in the current situation with 11% of mortgages and 17% of SME loans in deferral.

JP Morgan considers Bank of Queensland ((BOQ)) to be the best placed to pay a deferred first-half dividend. This is attributed to its material buffer to its target CET1 capital ratio range and less pro-cyclicality of risk-weighted assets. JP Morgan has reinstated a $0.10 per share dividend for the first half but reduced its second-half dividend.

None of the other major banks are expected to pay the deferred dividend. 

JP Morgan believes Commonwealth Bank may pay a final dividend of $0.85 per share, a 49% cash payout ratio. For National Australia Bank ((NAB)) and Bendigo and Adelaide Bank ((BEN)), the broker forecasts payout ratios of 42% and 45% in the second half.

UBS feels while the reporting season will provide a lot of insights, investors should not expect to get too much clarity. FY21 will see a renewed wave of charges when the full impact of the recession is finally felt.

How the banks perform, states UBS, is entrenched with the performance of the small businesses which drive unemployment and house prices, along with the ongoing government policy stimulus.

More support for the childcare sector in Victoria

With Melbourne moving to Stage 4 restrictions, the federal government has provided for additional support for the childcare sector in Victoria.

Some important highlights include parents not required to pay gap fees to operators if their child does not attend due to covid-19 related reasons. However, the operators will be able to claim subsidies for such children.

More measures in the form of additional days of allowable absences and transition payments have been introduced.

At a time when many may not be willing to send their child to childcare centres, these measures will go a long way in helping childcare landlords stay afloat, comments Goldman Sachs.

Analysts at Goldman Sachs have a Buy on Charter Hall Social Infrastructure REIT ((CQE)) as they consider current price levels make for an attractive investment opportunity.

The current soft pricing, they elaborate, is mostly from concerns over the ability of the childcare operators to meet their rental obligations.

The broker dismisses these concerns, emphasising the REIT managed to report strong rent collection even during the peak of the lockdown.

Goldman Sachs is Neutral on Arena REIT ((ARF)), considering it fairly valued even as it is confident about its ability to continue to invest across the social infrastructure spectrum.

The broker notes neither Charter Hall Social Infrastructure nor Arena REIT have material exposure to either Melbourne or Victoria. Charter Hall's REIT has the added advantage of a diverse tenant base.

General Insurance: A survey on pricing resilience

Morgan Stanley conducted an online survey of 1,250 Australian consumers with motor and home insurance cover.

The survey finds Insurance Australia Group ((IAG)) is in a stronger position than Suncorp Group ((SUN)), with 75% of the surveyed consumers not planning to downgrade their covers. This is just about 60% for Suncorp.

What this points to is that IAG’s customers are less price sensitive. It also highlights the emphasis the group puts on multi-policy cross-selling.

Due to its stronger position, IAG has more pricing power, observes Morgan Stanley, and is in a better position to reprice for higher catastrophe budget and reinsurance costs into FY21. Morgan Stanley has upgraded IAG’s FY21 insurance margin to 15.5%.

Suncorp customers, on the other hand, are more price sensitive. This is especially true for its AAMI brand which has seen a downgrade in home and motor insurance covers. The broker points out the group’s portfolio is running with a higher churn, a headwind to margins.

Suncorp’s FY21 insurance margin has been downgraded to reflect new business pricing strain and lower reserve releases. The broker is Underweight on Suncorp due to its higher losses, lower pricing prospects and a more price-sensitive customer base.

FX risks for offshore earners

Macquarie is of the view that increasing government support for infrastructure and construction globally will support a rise in commodity prices. We are currently in a commodities up-cycle, Macquarie notes. The broker points out the CRB Raw Industrials index which is up 7% from its April low.

This is when we are just one third through the up-cycle, in the broker's view, highlighting the rise has been broad-based with about 15-18 commodities up since the low.

One result is a higher AUD/USD rate. In a situation where the CRBRI rises by 20%, the Aussie rate will likely shoot up to $0.80.

The rising Australian dollar will hit companies with offshore revenue exposure. For stocks with more than 20% revenue exposure to the US/China, the consensus net profit for FY20-22 in AUD is already down -8% in the last three months. 

Macquarie highlights the market does not yet seem to be pricing in the potential impact of a stronger AUD on offshore earners. The broker counts 38 ASX300 stocks with 20% revenue from the US and China. They form 21% of the ASX300 index and have underperformed by nearly -5% over the last three months.

The higher AUD could lead to a disappointing guidance. 

The broker recommends reducing exposure to US/China exposed industrials. Stocks include QBE Insurance Group ((QBE)), ResMed ((RMD)), Ansell ((ANN)) and Nufarm ((NUF)).

ASX100 stocks with large US/China exposure and rated Neutral are CSL ((CSL)), Sonic Healthcare ((SHL)), Treasury Wine Estates ((TWE)) and Computershare ((CPU)).

For offshore exposure, Macquarie recommends exposure to resources stocks, and is Overweight mining with a focus on iron ore. It likes BHP Group ((BHP)), Fortescue Metals Group ((FMG)) and Rio Tinto ((RIO)).

Gold is also preferred through Evolution Mining ((EVN)) and Saracen Mineral Holdings ((SAR)). The third preferred sector is energy with Oil Search ((OSH)) and Worley ((WOR)) as key picks.

Stocks rated Outperform and with high domestic exposure are Telstra Corp ((TLS)), Charter Hall Group ((CHC)), GPT Group ((GPT)), Transurban ((TCL)), Sydney Airport ((SYD)), Spark Infrastructure ((SKI)), and Crown Resorts ((CWN)). 

While some of these will be negatively impacted in the short term by the lockdown in Victoria, including Crown, Transurban and GPT, the broker believes this creates a buying opportunity for investors.

Gold: Too good to be true

The price of gold has hurtled past the US$2,000/oz mark, driven by a weaker USD and sliding US real rates.

Macquarie believes these factors, while important, do not justify the current price levels. On the broker's valuation, gold is trading US$150-200 above its ‘fair value’ estimates. Macquarie warns a sharp correction may be in the offing.

In gold stocks, beyond Evolution and Saracen, the broker likes Resolute Mining ((RSG)) for debt reduction, and Silver Lake Resource ((SLR)) and OceanaGold ((OGC)) as they both present organic growth prospects. Other preferred picks include Westgold Resources ((WGX)) for its operational leverage and Bellevue Gold ((BGL)) with its potential for exploration.

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