In Brief: M&A Beneficiaries, Retail, Optus, World Trade & Mortgage Stress

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Rising global capital markets activity; preferences within retail; impact from potential Optus takeover; resilient world trade; and mortgage stress.

-M&A awakens. Who's to benefit most?
-Changing dynamics changing the retail sector
-The likely impacts from a potential Optus takeover
-Low point for the global economy, world trade resilient
-Mortgage stress rises, but employment remains strong

By Mark Woodruff

ASX Beneficiaries from a rebound in M&A activity

M&A activity has picked up over the last two quarters, and Morgan Stanley predicts a 50% recovery in global M&A volumes in 2024, driven by both cyclical and structural factors. 

While global capital markets activity is at near three-decade lows relative to nominal GDP, a rebound is expected to kick off this year and build momentum through 2025 and 2026.

The “M&A drought" will end in Australia and Europe, suggest the analysts, while Japan continues a structural shift towards greater corporate activity.

In Australia, M&A transactions have reverted to below normal conditions for the period pre-2021, according to Morgan Stanley, with 2023 in particular exhibiting far more muted deal activity.

Leading the activity charge will be M&A and debt capital markets, according to the broker, with emerging capital markets to follow.

Within Morgan Stanley research coverage of Australian Financials, Macquarie Group ((MQG)) and Computershare ((CPU)) are seen as the main beneficiaries of a recovery in global M&A activity. Macquarie has more leverage given its potential for gains on sale and revenue via performance fees, on top of M&A advisory fees.

Both Computershare and the ASX ((ASX)) are potential beneficiaries from a recovery in the broader capital markets but each comes with baggage.

While Computershare is unique in having leverage to a recovery in activity for debt capital markets in the US (which is happening faster than M&A completions), the broker explains a headwind will arise from lower margin income as US interest rates fall. 

For the ASX, M&A on its own could be a negative for total revenues, as it could lead to fewer listed companies, caution the analysts. Instead, this company specifically needs a recovery in the Australian IPO and emerging capital markets, as well a recovery in volumes for equities and interest rates futures trading.

The analysts maintain an Underweight rating for the ASX and currently have no rating for Computershare.

The clear winner from increased M&A activity is Overweight-rated Macquarie Group, with Morgan Stanley suggesting consensus is missing operating leverage from the expected revenue recovery. The broker's target is raised to $225 from $202.

A different perspective on retailing

The time has come to use FY24 as the base for forecasting the outlook for stocks in the A&NZ Retail sector, according to Citi, as opposed to ongoing comparisons made to either FY19 or the “pre-covid” period.

The analysts point out FY19 is an inappropriate benchmark for comparison given poor sales growth for the Discretionary sector in that financial year compared to prior years, particularly for household goods.

Plus consumer behaviour, businesses and categories have evolved since then.

Consumers are now allocating a materially higher share of wallet to clothing and footwear, recreational goods and household goods categories, with JB Hi Fi ((JBH)) and Kmart ((WES)) taking significant market share, explains the broker.

A lower share of spending on tobacco also hurts the Metcash ((MTS)) Food business relatively more than Coles Group ((COL)) and Woolworths Group ((WOW)), observes Citi, since tobacco is a much higher share of sales at Metcash.

Several company initiatives relating to gross profit margins and cost management suggest to the analysts margins will be sustainably higher for Kmart, The Good Guys, Supercheap Auto ((SUL)) and Premier Investments ((PMV)), with the latter also benefiting from renegotiated rents.

Citi claims to have a pretty good handle on how FY24 will play out for companies in the A&NZ Retail sector, and then applies an overlay of its own positive consumer outlook as a guide for FY25 forecasts. The performance in this financial year is expected to be supported by an estimated $50bn uplift in spending capacity.

Since pre-covid, the best retailers in each category have tended to improve their respective market conditions, and the broker doesn’t anticipate this trend will reverse for the likes of Kmart, JB Hi-Fi and Super Retail.

For supermarkets, Citi likes Buy-rated Woolworths Group and Coles Group, with an unchanged leaning towards Coles based on a higher conviction for earnings.

For discretionary retail stocks under the broker's coverage, the order of preference remains Harvey Norman ((HVN)), JB Hi-Fi, Premier Investments, and Super Retail, which all have Buy recommendations.

Rational mobile market after potential Optus takeover

Evans and Partners anticipates ongoing rational behaviour in Mobile for the Telecom sector in Australia should Singtel sell Optus to Brookfield Infrastructure Partners, as mooted by recent media reports.

The reported valuation range for Optus of between $16-18bn is considered supportive of sector valuations, with the implied earnings multiple significantly higher than current trading multiples for Telstra ((TLS)) and TPG Telecom ((TPG)).

The analyst anticipates rational pricing in the mobile industry because of the strategy employed by Brookfield after acquiring a 49.9% interest in Vodafone New Zealand in May 2019. New Zealand-based, ASX-listed infrastructure company Infratil ((IFT)) also acquired a 49.9% stake at the same time. 

In order to increase profitability and returns, One NZ (Vodafone NZ's new name) showed a willingness to cede mobile subscriber market share in order to increase profitability and returns, explains Evans and Partners. The company’s mobile subscriber market share fell to 35% in 2022 from 41% in 2018. Brookfield ultimately sold its 49.9% interest in One NZ to Infratil in June 2023, well above the initial acquisition price.

Similarly, Optus could flex mobile prices to improve earnings, with a higher average revenue per user (ARPU) essential to generate better returns. Ultimately, this course of action would be beneficial for the Telecom sector overall, concludes the broker.

Evans and Partners' current recommendations for Telstra and TPG Telecom are Positive and Neutral, respectively.

A low point for the global economy

Measures of supply chain pressures for world trade are edging up but are still broadly in line with the historical average, notes Oxford Economics, as part of commentary around increased attacks on shipping in the Red Sea. It's thought global trade was still holding up well in January based on current air and sea freight indicators.

Only around 15% of global sea trade travels via the Red Sea and some international shipping companies have added vessels and increased sailing speeds to partly offset the effective loss of between -5% and -9% of global container vessel capacity from the diversion.

While the impact appears manageable, and Oxford forecasts a gradual recovery in goods trade this year, risks are skewed to the downside.

If the clashes in the Red Sea intensify, the implications for world goods trade could become more significant.

In line with this view, analysis by the European Central Bank suggests geopolitical distance, defined as the average disagreement between any two countries, is playing an increasingly important role in determining global trade flows.

In one scenario Oxford assumes an escalation of the Israel-Hamas war triggers a historically significant degree of disruption to global oil supply, leading to an oil price spike to US$137/barrel, an almost -10% drop in stocks, and a tightening of central banks policy due to higher near-term inflation.

After an initial significant slowdown in global growth, the analysis points to a stronger recovery from the end of 2025, resulting in world goods imports returning over the medium-term to baseline levels.

Nightmare scenarios aside, the current tentative signs of a recovery in world trade volumes are consistent with Oxford’s opinion the low point for the global economy may have been reached and that we are headed for a soft landing. 

Following a -1.2% decline for world goods trade in 2023 (the worst performance over the past two decades excluding the global financial crisis and the pandemic), Oxford forecasts a 2.4% expansion in 2024. This increase would be a continuation of the weak longer-term trend where goods trade has been growing slowly as a percentage of world GDP.

Over the coming years, the contribution by China to world goods imports is expected to fall to less than half that of the US economy, as the Chinese property sector continues to drag on the economy.

For perspective, Oxford Economics highlights China's contribution to world goods imports in the late-2010’s outpaced that of the US economy.

Mortgage stress rises, but employment remains strong

February ushered in a new record-high for the total number of Australian mortgage holders considered ‘At Risk’ of mortgage stress, according to new research by Roy Morgan, despite the February Reserve Bank meeting resulting in an unchanged 4.35% cash rate. The present level for the cash rate is still the highest interest rates have been since December 2011.

Mortgage holders are considered ‘At Risk’ if their mortgage repayments are greater than a certain percentage of household income, depending on income and spending.

Because of the larger size of today’s Australian mortgage market, the 31.4% of mortgage holders in the ‘At Risk” category in February’s data is still well below the 35.6% record high attained in mid-2008 during the Global Financial Crisis. February's number represented a 0.4% increase on the survey results for the prior month.

Since the RBA began a cycle of interest rate increases in May 2022, the number of Australians ‘At Risk’ of mortgage stress has increased by 822,000.

While the impact of interest rates is significant, Roy Morgan highlights unemployment is the key factor which has the largest impact on income and mortgage stress.

As Roy Morgan CEO Michele Levine states “the variable that has the largest impact on whether a borrower falls into the ‘At Risk’ category is related to household income – directly related to employment. The employment market has been exceptionally strong over the last year, and this has underpinned rising household incomes that have helped to moderate the increases in mortgage stress since mid-2023.

Roy Morgan’s latest unemployment estimates for February show almost one-in-five Australian workers are either unemployed or under-employed.

Should there be a reacceleration in inflation over the months ahead, resulting in further interest rate increases in 2024, Roy Morgan fully expects mortgage stress will set new record highs later this year.

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