In Brief: Gas, Gold, Groceries & Aussie Banks

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Weekly Broker Wrap: UBS sees structural demand change for gold, east coast gas shortages a threat; grocery prices hit rock bottom; and Aussie Banks too expensive to mention.

-East coast gas demand remains below 2023 levels
-UBS expects gold to maintain its shine
-Overseas trends point to a bottom in domestic grocery prices
-Banks are more highly valued than even a bear thought

By Danielle Ecuyer

UBS grabs gold by the “bullish” horns

In a comprehensive analysis of the Australian gold mining sector and the macro drivers behind the gold price, UBS has upgraded its outlook for the price of gold bullion, leading to an across the board upgrading of forecasts and price targets for Australian gold miners.

UBS highlights major structural change for the global gold market.

The analysts note there has been a move towards strong “official” gold purchases, think sovereign states, as well as resilient demand for physical gold (jewelry, for example). 

Increased geopolitical risks and global macro concerns are expected to continue to underpin demand and any gold taken off the market is not considered as coming back to the market in the foreseeable future.

Importantly, investors are seeking out increased gold holdings, with UBS alluding to the fact many are underweight, while the private wealth community and longer-term investors have yet to catch the gold buying train.

The broker envisages the next move higher on the gold price stems from a global re-allocation to the asset class from this group of investors.

In the near term, the US Presidential election is a potential trigger for higher gold prices to move higher on the back of political uncertainty.

Where to for the gold price forecast?

UBS has increased its gold price forecasts by 8% in 2024, 21% in 2025, 34% in 2026, 30% in 2027 and 18% in 2028, to respectively US$2,365/oz, US$2,700/oz, US$2775/oz, US$2600/oz, and US$2,300/oz.

On inspection, the analysts believe upgraded forecasts are between 27%-33% above consensus forecasts over 2025-2027, with ASX-listed gold miners currently priced for bullion trading between US$1660-US$2090/oz.

The broker also raises the long-term real price by US$200/oz to US$1,950/oz against consensus sitting at US$1,780/oz.

In AUD terms, UBS estimates gold reaching $4,000/oz by the end of 2025 which has resulted in material target price rises for Australian gold producers. More details are available in The Broker Call Report of May 5.

Are gas supply disruptions a risk for the winter months?

Jarden has updated its east coast gas tracker with the start of winter and what is traditionally a critical period for the South Australian market.

Weaker gas demand has continued into 2024, with cumulative demand until the end of May down -8% on the previous corresponding period in 2023. Victoria’s demand fell -11% which the broker attributes in part to demand destruction resulting from higher retail gas prices in 2023.

Interestingly, non-gas-powered generation (GPG) demand is also weaker, with the seven day average demand running below 2023 and levels of recent years, consistently.

The market shows cumulative GPG demand is still higher than the comparable period in 2023, but well below the 2019-2022 period which the broker attributes to high coal availability and lack of electricity supply disruption.

Jarden is forecasting 2024 east coast demand to remain some -5% below the 2023 level.

Will various disruptions impact the market?

In May, cooler weather, coal outages in NSW and what Jarden described as the “surprising” operation of Tasmania’s Tamar Valley Power Station, all culminated to increase GPG gas demand to the highest monthly demand since July 2022.

Regarding supply, lower production from Longford due to planned maintenance is keeping southern production below the 2023 level, with higher levels of supply from Otway, Orbost and Moomba not making up the shortfall in output from the Longford gas field.

Year-to-date Longford output is down -24% compared to the same period last year.

The broker highlights Iona storage was used to meet the supply shortfalls, but there was a resulting spike in gas prices.

Jarden stresses the fragility of the gas markets to spikes in demand during colder periods on top of other factors that impact on markets, suggesting on current estimates South Australia will need to increase more supply capacity by 2030, particularly with the expected decline in Longford production over the decade.

Prices remain well down compared to May 2023, by -9%, even with the recent gas price spike, due to the cold start to winter last year in Victoria and other states.

The average May price was -28% below the prior year, but 13% above April 2024.

Jarden is Neutral rated on Woodside Energy Group ((WDS)) and Overweight on Santos ((STO)), Origin Energy ((ORG)), APA Group ((APA)), Beach Energy ((BPT)) and Cooper Energy ((COE)).

The latter has been identified as a specific beneficiary of expected higher gas prices in 2026, assuming the company can increase higher production rates at Orbost and unlock Otway gas potential.

Australian grocery markets, what the overseas experience reveals

Jarden has undertaken a deep dive into domestic grocery prices to assess probable outcomes in comparison with what has transpired overseas. The analyst reviewed nine companies across the UK and US for insights into what could develop in the domestic grocery market.

The US/UK markets are viewed as three to nine months ahead of Australia regarding inflation trends. These markets have shown slowing inflation leads to a rise in demand. The analyst notes across the US and the UK, there has been a 2–6ppts improvement in volumes as inflationary pressures eased.

Jarden assesses the current grocery outlook is near the bottom of the cycle and all things being equal, based on the overseas experience, volumes should recover by a similar amount of 2-6ppts. 

This forecast is composed of population growth of circa 2% and a possible 1.5% uplift from eating at home. Looking out to 2024/25, volume growth should improve and expected sales growth is between 4%-5%.

The broker also highlights increased competition between own-private labels and branded consumables has risen. 

The UK has the second largest own-brand market globally at 46% (Switzerland is the leader at 52%), with a 30% rise in private label spending over the past year, driven by 20% own brand growth from Tesco and Sainsbury.

Australia is depicted in with the middle range with around 30% own brand market share; Coles Group ((COL)) is ahead with growth of 8% year-on-year in 2024, leading Woolworths Group ((WOW)) with 4% growth. 

Overall, Jarden believes investment in own brands for the “premium” rated companies, Woolworths, and Metcash ((MTS)) needs to be raised with Coles currently in the lead.

Other major takeaways include those companies offering a clear “value proposition” have benefited the most from slowing inflation, including Sainsbury in the UK and Walmart in the US.

There is also a shift in consumption trends back to traditional grocers in the UK, as Aldi’s popularity has peaked and, in the US, via the rise in Costco and Walmart.

Jarden concludes volume growth should improve domestically and major operators should be in a position to increase market share via own brands and possibly improved loyalty programs.

The broker is Neutral rated on Coles, and Overweight rated on Woolworths, Metcash, and The Reject Shop ((TRS)).

Banks, how overvalued?

Whichever way Goldman Sachs cuts the assessment cake of Australian banks versus overseas peers, the broker comes away with the resounding conclusion Australian bank valuations are stretched and “heavily skewed to the downside”.

The broker is quick to highlight domestic banks have always been more highly valued than offshore peers, but the widening in the discrepancy is causing more reasons for concern.

Making some financial ratio comparisons, the broker points to the decline in Australian banks’ return on equity (ROE), which was the second highest globally, just behind the Canadian banks, in 2015, and has since underperformed global comparable banks by circa -50%.

Domestic banks are now generating some of the lowest ROEs in the world.

Over the same period the price-to-book (P/BV) ratio has also declined, which is in line with the trend exhibited by global comparable banks. However, on a ROE to P/BV comparison, Goldman Sachs stresses the domestic banks at 1.9x P/BV for 11% ROE versus global peers at 1.9x P/BV for 13% ROE implies Aussie banks are the most expensive in the world.

Goldman Sachs observes another metric which reveals the decline in profitability for Australian banks between 2015 and 2023. Over this period the banks' gearing has increased, but the decline in net profits is worse when comparing to interest bearing assets.

The deterioration in profitability between 2015 and 2023 is attributed to the decline in net interest margins (NIM) where the domestic banks have not experienced the same leverage to higher interest rates, largely due to mortgage competition, notes the broker.

Interestingly, the decline in fee generation has also been a large contributor to the deterioration in profitability relative to overseas peers.

In contrast to Australian banks, global banks are looking to generate more non-spread income (deposit/lending) to diversify away from credit risk, whereas domestically, the royal commission forced banks to reconsider their corporate structures and divest wealth management operations, thereby removing the higher margin operations.

In terms of costs and bad and doubtful debts, global banks experienced more volatility in the loss ratios over covid.

Lastly, Goldmans Sachs models the ROE versus the price-to-book ratios to provide another tangible valuation assessment and concludes Commonwealth Bank ((CBA)) has an expected one year forward ROE of 12.7% and should thus trade on a price-to-book of 1.2x, but the shares are trading on 2.7x, a 130% premium to this implied valuation method.

Historically, Commonwealth Bank shares have traded at a 56% premium to its ROE on the regression analysis against the current implied premium of 130%. 

The broker stresses “we are in unchartered valuation territory” and the report re-affirms the more negative stance the sector analysts have adopted on domestic banks recently.

Goldman Sachs is Buy rated on ANZ Bank ((ANZ)) and Judo Bank ((JDO)); Neutral rated on National Australia Bank ((NAB)) and Bendigo and Adelaide Bank ((BEN)), with Sell ratings on Commonwealth Bank, Westpac Banking Corp ((WBC)) and Bank of Queensland ((BOQ)).

For more about Australian banks:

https://fnarena.com/index.php/financial-news/australian-broker-call-archives/?n=07BE6705-9CB1-938D-4C622062BEF532A3

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