In Brief: Banking, Electric Vehicles, Retailers & Lithium

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Republished to correct the name of Oxford Economics in the story on global banks and housing markets, as well as the downgrades of retailers by UBS.

Weekly Broker Wrap: pressures on the banking system; electric vehicle purchasing intentions; an accelerating consumer slowdown & lithium markets.

-Global and domestic pressures on the banking system 
-Purchasing intentions for electric vehicles 
-Brokers anticipate a further consumer spending slowdown 
-The lithium market outlook and benefits of integration 

By Mark Woodruff 

Global and domestic pressures on the banking system 

The risk to the banking system of a global housing market downturn remains significant, according to Oxford Economics, despite the main concern to date being the holdings of government debt by commercial banks.

While banking risks are relevant to both emerging markets and advanced economies, the latter are more afflicted with house prices collapsing, households being more indebted and banks maintaining thinner interest and profit margins, explains the senior economist.

Moreover, falling capital market valuations are putting pressure on financing conditions.

Within the advanced economies, the Netherlands, France, Germany, Finland, Cyprus and Spain stand out as countries where risks are already high of a housing crisis, and Oxford Economics believes those dangers are increasing.

House prices are falling in response to rising interest rates in the advanced economies, with Canada, New Zealand, Hong Kong, Sweden and Denmark having already experienced drops in prices of around -10%-15% year-on-year.

In coming quarters, nominal price growth is also expected to turn negative in the UK, US, Ireland and France.

At present, there have only been two to three quarters of negative house price growth, with a lag of about eight quarters from the onset of the price falls typically a key trigger of housing crises, explains Oxford Economics.

Taking into account both house price falls and overstretched bank balance sheets, Canada, Denmark, Finland, Netherlands, Germany, and Sweden are considered most vulnerable. For eurozone banking systems, Oxford Economics observes balance sheet vulnerabilities are a key source of weakness.

As GDP growth slows, unemployment is forecast to rise in most advanced and emerging economies over the next 12-18 months. When combined with higher mortgage rates, housing affordability is expected to become even more precarious.

Thankfully, according to the economists, bank balance sheets in Australia, South Korea and China look more resilient.

Morgan Stanley also notes bank balance sheet settings in Australia are robust and valuations are not expensive in an historical context. 

However, it’s anticipated bank share prices in 2023 will be weighed down by further downgrades to consensus earnings estimates and tail risks from the RBA's "quick and aggressive" tightening cycle.

The broker believes earnings have peaked for the major banks, with the macroeconomic and competitive environment likely to drive slower loan growth, falling margins, growing cost pressures and rising impairment charges.

In the prevailing environment, Morgan Stanley suggests bank share price performance will be influenced by the ability to mitigate emerging margin headwinds and limit cost growth relative to current expectations.

Moreover, management of credit risk associated with higher rates and a weaker economic outlook will be key, and the broker expects an increasing investor focus on credit quality, provisions and loan losses, given ongoing RBA rate hikes, emerging signs of household stress and weaker consumer spending.

Loss rates at the major banks averaged only around -2bps of loans in 2022, but increased to circa -12bps in March 2023 as the benefit from collective provision releases and write-backs began to fade, explain the analysts.

Morgan Stanley forecasts loss rates will average around -14bps in the June quarter, and then anticipates some further deterioration in credit quality in the second half of the year. 

The broker anticipates impairment charges will reach around -25bps of loans in the September quarter and average -27bps for FY24, which compares to the -19bps consensus estimate.

Purchasing intentions for electric vehicles 

Up to March 2019, only 41,000 Australians intended to purchase an electric vehicle (EV) within the next four years, but new Roy Morgans research shows this figure has jumped materially to 548,000.

The popularity of the Tesla brand accounts for most of the rise, with the research showing 369,000 Aussies are looking to purchase the leading EV maker.

“Tesla is now the sixth highest selling brand in Australia behind five well-established Asian vehicle manufacturers – Toyota, Mazda, Mitsubishi, Hyundai, and Kia”, points out Michele Levine, CEO of Roy Morgan.  As recently as 2022, Tesla was only the 16th largest selling brand of car.

Although Tesla is clearly the market leader for EVs, there are now around 180,000 Australians who want to buy an electric vehicle, but not a Tesla, as other manufacturers such as BMW, Mercedes, Volvo, BYD and MG launch competing brands, explains Michele Levine.

The latest Roy Morgan data show a 61:39% split of men and women planning to buy an electric vehicle, a significant change from the 76:24% ratio in 2020.

Apparently, your typical ‘Tesla man’ is an ALP-voting married man in his 50s, or early 60’s, living in a detached house (which he owns), and has a predilection for spending big on discretionary items, according to the research. 

Brokers expect an accelerating consumer spending slowdown 

Consumers in 'mortgage belt' Australia are expecting to sharply reduce their spending on 'fun' categories, such as entertainment, recreation, eating out, takeaway food and international travel.

A year after interest rate hikes began, it seems middle-income households are now being hit hard, according to a recent survey conducted by UBS. Sticky inflation means it has been difficult to scale back on cost-of-living expenditure categories in nominal terms.

While a strong jobs market has prevented a consumer collapse, UBS is wary of the impacts from a potential rise in unemployment. The economics team forecasts unemployment will lift substantially through 2024 towards around 5%, following additional RBA rate hikes.

UBS expects the spending slowdown to accelerate from here, as consumers expect another 100-300bps rise in mortgage rates, having already experienced a 300bps increase over the last year.

Many low-income consumers have now run out of savings after building a buffer through the covid years. Cost of living is increasing for all income earners but more for low- and middle-income earners, with utilities, petrol and rent increasing most.

By contrast, those on high incomes have ample cash balances and the ability to draw down on investments, survey results show.

According to Morgan Stanley research, the savings rate has now fallen below average levels while the deceleration in retail spend continues, suggesting buffers are fast being depleted.

Around 40% of outstanding mortgage borrowing in Australia is at a fixed rate and 65% of these mortgages roll-off over this year and next, with the biggest concentration in the second half of this year, observes this broker. 

For an average borrower, moving to 6.5% from 2% represents a -12.5% disposable income headwind.

Stocks selected by UBS with a customer base skewed towards the high-income group include: Autosports Group ((ASG)), Breville Group ((BRG)), Netwealth Group ((NWL)), Qantas Airways ((QAN)), Scentre Group ((SCG)), Select Harvests ((SHV)) and Treasury Wine Estates ((TWE)).

More negatively, in the current environment, stocks with exposure to low-income earners are considered to be: Charter Hall Retail REIT ((CQR)), Collins Foods ((CKF)), Super Retail ((SUL)) and Region Group ((RGN)).

In addition to avoiding big ticket retailers such as Harvey Norman ((HVN)), UBS also wishes to avoid retailers that sell to middle Australia or that have been beneficiaries of a more exuberant consumer during covid such as Premier Investments ((PMV)) and Super Retail ((SUL)) or are more exposed to higher cost-of-doing-business (CODB), most notably labour costs in the case of Premier Investments, Accent Group ((AX1)) and Universal Store ((UNI)).

This week, the broker downgraded its ratings for Accent Group, Premier Investments and Super Retail to Sell from Neutral, and upgraded Woolworths Group ((WOW)) to Buy from Neutral on potential for increased market share. 

For more detail on rationale and target price changes by UBS, please refer to stock analysis or the Broker Call Report on the FNArena website.

The lithium market outlook and benefits of integration 

Macquarie remains constructive on the outlook for the lithium market after pricing has stabilised following a correction in the first quarter of 2023.

The transition to electric vehicles accelerated again in May aided by price cuts by original equipment manufacturers (OEMs), explains the broker, and a production recovery in Europe. 

Moreover, downstream lithium inventory levels in China peaked in March after a quick rise in the first two months of 2023.

Nonetheless, to adjust for weaker second quarter spot prices, Macquarie lowers its spodumene and China LCE (battery grade) prices by -9% and -15% to US$4,837/t and RMB377k/t, respectively.

These changes have flow-on effects for 12-month target prices for lithium stocks under the broker’s coverage which can be viewed on the FNArena website under stock analysis or the Broker Call Report of June 21.

Mineral Resources ((MIN)) and Plibara Minerals ((PLS)) are Macquarie’s preferred producers, while Patriot Battery Metals ((PMT)) and Galan Lithium ((GL1)) provide the greatest near-term exploration upside.

At the start of the week, Citi made some interesting observations after attending a briefing hosted by Allkem ((AKE)) and US-listed Livent around their rational for a merged entity and general market conditions.

The future is all about integration, according to both companies, with OEMs desiring to buy reliable volumes at scale with minimal impurities. 

It’s thought those producers that maximise value from every lithium molecule, via integration, will succeed, as highlighted by the recent resilience of hydroxide pricing.

The majority of chemicals transactions are not being done at spot, explained the companies, with longer-term contracts focusing on product specifications in the parts-per-billion. 

Moreover, there are significant variances within and across markets, with carbonate and hydroxide markets very different beasts, as are the China and ex-China markets.

It was also noted direct lithium extraction (DLE) is not a silver bullet as it is more expensive and requires more capital, fresh water and energy.

Citi retained its Buy rating and $17.40 target for Allkem.

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