In Brief: Share Picks For 2024, China & Lithium

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Morgans best ideas for 2024; impacts from the ongoing property downturn in China & lower lithium price forecasts.

-Morgans Best Buys on the ASX for next year
-Chinese property’s structural downturn 
-Lower lithium price forecasts impact share valuations

By Mark Woodruff

Morgans Best Buys on the ASX for next year

Investors may need to exert near-term caution in 2024 as tailwinds from commodity prices fade, according to Morgans, making above-average earnings growth in the Australian stock market more difficult to achieve.

The broker is targeting the best relative opportunities, which include small caps and quality cyclicals with a preference for stocks within the Consumer Staples, Healthcare and Financial sectors, as well as select stocks from within Travel.

Overall, Morgans anticipates another two interest rate increases in Australia, and expects rates will stay higher-for-longer due to sticky inflation. It's felt equities will likely remain range-bound, unless more certainty emerges around peak or falling interest rates.

The broker explains small and mid cap stocks on the ASX have de-rated in 2023 due to higher interest rates and their risk-reward profile now looks attractive, despite potential for a recession.

A mild recession would actually be positive for property generally, and there may be opportunities within the retail/commercial REIT space, explain the analysts, as a small amount of inflation is positive for real estate. Also, despite a material rise in construction costs over the past few years, development pipelines continue to be a driver of growth for many REITs.

Morgans also sees value in mid-to-small cap technology shares. Guardians of the broker’s Best Ideas list include NextDC ((NXT)) and Objective Corp ((OCL)) after 2023 outperformance by larger, quality names in the space, though warn investors to expect higher risk and higher share price volatility at the small end.

For Consumer Staples, the analysts see a tailwind from population growth and not a lot of downside risk, due to the sector’s defensive characteristics, strong balance sheets and consolidated industry structure. Wesfarmers ((WES)), Treasury Wines Estates ((TWE)) and a2 Milk Co ((A2M)) are recommended.

Regarding the Healthcare sector, a comeback has been underway since the beginning of November, and the broker sees further upside potential as procedural and testing volumes normalise following covid.

Also, several companies including CSL ((CSL)) and ResMed ((RMD)) are set to recover further from unwarranted share price selloffs, in the analysts’ view, in reaction to growing demand for weight-loss drugs. Mach7 Technologies ((M7T)) also features among the broker’s Best Ideas list.

Travel demand is still recovering from covid, so all companies under coverage in the sector by Morgans are well placed to grow earnings in 2024, while the broker sees more tailwinds than headwinds for the broader Insurance and Diversified Financial sectors.

Morgans’ Best Ideas in Travel are Corporate Travel Management ((CTD)), Flight Centre Travel ((FLT)) and Helloworld Travel ((HLO)), while preferred stocks in Diversified Financials are QBE Insurance ((QBE)), GQG Partners ((GQG)), WH Soul Pattinson ((SOL)) and Tyro Payments ((TYR)).

Chinese property’s structural downturn 

The property downturn in China is not simply a supply-demand imbalance caused by a cyclical slowdown, highlights ANZ Bank, which is ruling out the possibility of a 2024 recovery for the sector.

The bank believes the downturn is a structural phenomenon caused by the government’s housing policy, namely common prosperity, which has likely caused a permanent shift in buyers’ appetite. 

Oxford Economics agrees the slowdown is structural in nature, and the real economic impact of the property downturn will be sizeable and prolonged. Nonetheless, it's believed authorities will be able to manage the downturn without causing a financial crisis.

The banking system is used by Chinese authorities during property downturns as a counter-cyclical tool, explains Oxford.

A twin approach halts negative feedback loops that were experienced in other countries such as the US and Spain during times of property weakness.

Firstly, banks are asked to expand their loan books to support ailing developers, points out Oxford, as opposed to a tightening of credit conditions.

Additionally, household mortgage terms are stringent, with high down-payment ratios for second and third homes, which ultimately lessens the odds of widespread mortgage failures.

However, the Chinese government is in somewhat of dilemma, according to Oxford, with a structural goal to move away from a reliance on property, countered by a cyclical desire to get property activity moving again.

Leverage-based limits imposed by authorities curtail the extent of developers' access to future financing, with 44% of Oxford’s sample pool of onshore developers breaching all three of the leverage-based criteria, while 28% have breached at least two.

Given a large backlog, funding pressures for project completion needs will likely persist, according to Oxford. It’s thought the backlog may take at least another four years to unwind, absent a meaningful pickup in demand.

Furthermore, organic and structural demand will roughly halve by 2030 from 2022 levels, driven by ageing demographics and slower urbanisation, explains Oxford.

According to forecasts by the United Nations sourced by Oxford, the population group in the 35-54 age range will shrink at an average pace of -0.7% every year until 2030.

With the population declining, the inventory level will continue to build up, suggests ANZ Bank. Currently, it takes two years for China to digest unsold floor space.

Even if the government opts to spur activity by pushing out shorter-term working-capital loan facilities to lower the incidence of developer defaults, this alternative is unlikely to spur bank lending in a more sustained manner, in Oxford’s opinion.

Additionally, large state-owned banks face the risk of further asset-quality deterioration, notes Oxford. In the absence of regulatory assurances, they are naturally unlikely to have the appetite to loosen underwriting standards. 

The banking system cannot 'rescue' the sector out of the necessary multiyear structural correction process that is underway, according to Oxford, apart from reducing event or headline risk in the housing market. 

Nonetheless, a positive by-product of reducing these risks is support for activity in adjacent economic segments such as private investments and consumer spending, explains Oxford.

In a further positive, ANZ predicts holiday spending and domestic tourism will be vibrant in 2024, given government policy is designed to support the development of ‘domestic circulation’. 

Households will mainly spend their holiday domestically, in the bank’s opinion, and holiday consumption will likely reach a record high in 2024. 

While outbound travel arrangement with other countries will be eased gradually, pre-covid levels won’t be attained, according to the bank's forecast.

ASEAN countries such as Thailand likely to be the first to experience an inflow of Chinese tourists, according to ANZ Bank.

UBS lowers lithium price forecasts and share price targets

While UBS finds it difficult to be all-out negative on the lithium market, which by conservative estimates will either double or triple by 2030, a lower price environment will have repercussions.

A supply response to lower pricing may take the form of added scrutiny for new greenfield projects and/or a rethink of brownfield investments by incumbents, suggests the broker.

As market prices continue to grind lower in the face of weakening demand sentiment and a robust supply outlook, UBS lowers its 2024-26 lithium price forecasts by -45%, -35% and -23%, respectively.

As a result of these new price projections, valuations for lithium shares under the broker's coverage fall by between -8-19%, due to significant EPS downgrades. 

UBS also downgrades its rating for Pilbara Minerals ((PLS)) to Sell from Neutral and lowers the target to $3.05 from $3.75.

While there is no risk to production growth plans, the broker feels the market will likely focus on realised price for Pilbara Minerals' current 5.2% lithium oxide product. The company's declining cash balance during a heavy investment phase is also expected to weigh on sentiment.

The analyst also reduces its target for IGO ((IGO)) by -14% to $10.50. As potential remains for a greater than 20% return for investors, the Buy rating is kept.

Upside is possible for IGO after a near-term update by management on the Cosmos nickel mine, suggests UBS, along with new impetus for the overall business from incoming CEO Ivan Vella.

While improved earnings from iron ore at Mineral Resources ((MIN)) could offset a weaker lithium business, the broker is maintaining a watching brief on cash flow impacts as progress is made through the capex cycle, and as any potential M&A/investment in lithium juniors arises.

UBS maintains a Sell recommendation for Mineral Resources and the target is lowered to $49 from $53.

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