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In Brief: Rate Hikes, Banks, Insolvencies, Groceries

Weekly Reports | Mar 17 2023

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The weekly broker wrap: tightening economy, flow on impacts in banking, insolvencies remain low, supermarket competition to intensify. 

-While the RBA struggles to slow consumption, house prices are feeling the impact
-Events unrolling across North American banks are likely to impact the domestic majors
-Subdued activity from the ATO has kept insolvencies low, but construction companies remain at risk
-Supply chain investment sees grocery majors remain competitive 

By Danielle Austin

Reserve Bank interventions failing to have desired impact on consumption 

Evans and Partners has observed normal monetary policy enactment by the RBA does not appear to be delivering normal results on the economy, and the broker expects may not through this tightening cycle.

The broker points to a number of reasons as to why rate hikes are yet to sufficiently slow the economy. Firstly, massive excess savings were accumulated by consumers during the pandemic which are now sustaining consumption despite ongoing rate hikes;  secondly, corporate investment remains robust; and thirdly, the exchange rate has fallen rather than risen as is normally expected during rate hikes, due to more aggressive interventions from the US Federal Reserve. 

The need for the RBA to slow the economy remains, suggests Evans and Partners, and the broker points out that housing prices appear to be the only channel where interventions are having impact. Given this, it expects this channel to feel more pressure moving forward as the tightening cycle continues. 

House prices have declined -9% in the last year, while approvals for new projects have fallen to a decade low. The broker expects that should economy slowing interventions continue, mortgage holders, and the overall housing market, will bear the brunt. 

According to the broker, neither banks or housing company stocks appear priced for negative impacts of an ongoing housing market decline. It points out with domestic banks price-earnings ratios remaining elevated, they are particularly vulnerable to a decline in housing activity. Evans and Partners expects these risks to prove particularly evident in the third quarter with a large number of borrowers expected to refinance to floating rates.

Expect flow-on impact on domestic banks from North America to be modest 

Following the collapse of Silicon Valley Bank in the US, and a subsequent share price slide for the North American majors, the market has eyes on impact on Australian banks. While Morgan Stanley sees modest risk for the Australian majors, lessons were learnt from the GFC and banks have since strengthened their liquidity, funding and capital which should provide some buffer. 

The broker expects the events unfolding in North American banking will add upward pressure to wholesale funding costs and increase competition for stable deposits, but that the majors are prepared. 

Morgan Stanley notes the majors had an average bank liquidity coverage ratio of 132% in the December quarter, which implies around $172bn in excess liquid assets. Further, the majors had an average major bank net stable funding ratio of 122% for the same period. With deposits and equity accounting for 70% of funding, Morgan Stanley points out the majors have a collective $315bn in term debt maturities across FY23 and FY24. Finally, held capital for interest rate risk in the banking book has increased by $110bn since June 2021, or $12bn in capital for future interest rate risk. 

Insolvencies continue to lag expectations, but construction remains at risk 

With the Australia Taxation Office remaining more passive than Jarden had anticipated, insolvencies have lagged expectations. The broker had expected the ATO would ramp up enforcement activity over the second half of 2022 and drive an increase in insolvencies, but while insolvencies are on the rise they remain -20% below pre-covid levels.

The broker expects part of the reasoning behind the ATO’s lack of action is a desire to not make a challenging macro environment worse, but also notes the ATO has expressed a preference for companies to to wind up voluntarily rather than as a result of an issued winding up application, to avoid legal costs. 

Bucking the trend, insolvencies have continued to rise in the construction sector and are now at record highs. Cost inflation, supply constraints and project delays all continue to impact, and the sector is facing tighter credit conditions as banks are proving less likely to lend. Further, a lack of demand presents an emerging challenge to the sector, with Jarden anticipating a potential pipeline void from 2024. Outside of construction, sectors under pressure include domestic tourism, aged care and hospitality. 

Omni-channel supply chain investment key to remaining competitive in groceries 

Seeking to better understand the upside opportunity available to both Coles Group ((COL)) and Woolworths Group ((WOW)) from recent supply chain investment, Goldman Sachs points out both retailers have invested in fulfilment options in a bid to leverage both in-store and on-line growth. 

The broker is anticipating the competition for market share will intensify in the supermarket industry as growth moderates due to slowing inflation, and expects growth across multiple channels to be key to retaining market share. Recent investment, says Goldman Sachs, has made strategic divergence in convenience and range and availability between Woolworths and Coles more apparent. 

Goldman Sachs does expect Woolworths to retain its online market leading position with a 57% share, but expects Coles to close the gap with a 39% share. It also sees Metcash ((MTS)) as a clear casualty of slowing industry growth. Anticipating Metcash loses market share over FY24 and FY25, the broker has cut its earnings per share forecasts -2%, -13% and -13% through to FY25.

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