By Andrew Nelson
Putting global issues aside for the most part, we take a look at what local brokers had to say about a number of domestic issues last week. Key topics include Australian household cash flow and the housing market, mining tax impacts, insurers and lower RBA cash rates, the local ad sector and the current state of US consumers.
Starting with a bit of good news on the domestic front, economists from UBS pointed out that Australian household cashflow is actually posting steady gains and will continue to do so as the combination of lower interest rates, carbon tax compensation and budget cash handouts will continue to be felt.
Unfortunately, that begs the question: how long and how much of a boost?
Over the coming year, UBS is expecting household free cash flow to double from 4% year on year in 1Q12 to over 8% year on year by 1Q13. Shorter-term, the increase to household cash flow over 2Q-3Q will amount to about 2% of income and while the broker admits this is not the type of double-digit growth we saw in 2007 or 2009, it is still the strongest growth rate in 3 years.
However, UBS tempers its good news, noting that while household cash flow may well be increasing, there is no guarantee this will flow through to actual increases in consumer spending and, subsequently, the retail sector.
In fact, the broker has some serious doubts about the near term, noting the current trend is to reduce debt and increase savings given the lack of optimism in overall consumer sentiment. And with consumption already running at about half of trend, the broker expects a continued mix of negative news from Europe and the US, plus the hostile domestic political environment, will probably continue to limit the pace of spending growth.
There is a light at the end of the tunnel, however, with UBS expecting the improving levels of household cash flow to eventually start providing a bit of help to consumer spending and housing activity over the coming year. However, the broker warns we’ll need to see some signs of stability in Australia’s non-mining economy to avoid higher unemployment and maintain the trend.
Analysts from JP Morgan took a look at housing activity and note finance data so far this calendar year have been disappointingly weak, with total home loans falling 4.3% over the previous quarter. The broker notes the decline walks hand in hand with the downturn in first homebuyers (FHB) activity over the same period.
The broker explains that at least part of this is due to the flurry of buying activity over the latter parts of 2011 as first time buyers rushed to take advantage of the NSW transfer duty exemption, which expired at the end of the year. Given NSW is the nation’s biggest housing market, this has had a significant impact. Other tax and fee reduction schemes in Victoria and Queensland, the nation’s next two largest housing markets, are also starting to expire, which the broker thinks will have a similar effect as that seen in NSW.
The slowing rate of first time homebuyers has done a lot to contribute to the steady decline in house prices over the past year, notes the broker. The broker points out that the lower income nature of these buyers is one of the main drivers of price fluctuations at the lower end of the market.
In fact, the broker notes that since 2010, prices of the bottom 20% of dwellings have continued to decline as the number of new loans to first time buyers has declined. However, the declines at the bottom end are nowhere near the size of those at the top end, where prices have fallen heavily over the past year as consumers become more debt averse on fears of a serious domestic slowdown on the back of economic troubles offshore.
That said, the broker does see signs of support for housing prices emerging. Firstly, the broker notes cheaper house should go some way to support demand. JP Morgan points out that actually, the average loan size over the past year has fallen at the same rate as house prices, meaning consumers are only borrowing less because houses cost less. The fact consumers are still willing to acquire mortgage debt should well be supportive of the market.
Another supportive factor is that building approvals tend to fall in line with a slower lending rate, meaning supply has fallen with demand. The broker reasons this should also help limit the downside for Australian house prices and continue to offset weak consumer demand.
Another interesting phenomenon taking place in the Australian market is the impact falling cash rates are having on the insurance sector. Analysts from Bank of America-Merrill Lynch point out that the post GFC cuts to the cash rate had some significant consequences for several of insurers the last time around.
The broker notes Insurance Australia Group ((IAG)) had to write down around $50m in its intermediated business 1H09, which was blamed on liability adequacy tests (LAT) post the last big round of interest rate cuts. At the same time, Suncorp (( SUN)) also reported a $33m expense, again blaming an LAT failure due to the large drop in interest rates. BA-ML suspects there is again a risk from the negative impacts on profits from LAT failures.
The broker also notes a sustained period of lower rates will also have longer term implications on the capital positions of insurers as well as on the future pricing of insurance products. Long tailed lines in particular, points out the broker, will have to take into account the additional cost of capital as well as future yields when setting premiums. Right now, premium rates are rising and claims trends appear to be supportive, but the broker points out that this will remain an ongoing concern in the near term for all three major domestic insurers.
UBS also took a look at the two new taxes that will apply to Australian miners as of today, the Minerals Resource Rent Tax (MRRT) and the new carbon tax. The broker notes the former only really applies to the iron ore and coal industries, while the latter will be levied at the entire Australian industry.
Initially, the broker sees the MRRT as being pretty much a tax on iron ore, as coal miners boast lower margins and pay larger royalties than iron ore miners. However, the broker thinks the coal miners will definitely feel the brunt of the carbon tax, with coal miners expected to see a $1.50-$2.00 per ton increase to costs. Gas miners will also feel the pinch, with costs rising $5-$6 per ton.
All up, the broker notes both taxes will hit BHP Billiton ((BHP)) and Rio Tinto ((RIO)) earnings by around 3%-4% a year and valuations by as much as 3%. Meanwhile, the coal and iron ore industries should also see mostly single-digit impacts to earnings and valuations, on the broker’s numbers.
After a detailed look at the drivers of the Australian ad market, Citi is starting to see an increasingly significant correlation with macroeconomic data, leading the broker to think sentiment has become the key driver of domestic ad growth.
Given the current global macro outlook, the fact that Australian consumer confidence remains rooted in negative territory, the fact the ASX 200 has fallen 8% since from its May-12 peak and given the Aussie is still so high and is likely to be for a while, Citi expects ad growth will remain subdued for at least the rest of 2012.
Last on our list of last week’s interesting coverage was analysis from Citi showing real consumer spending in the US has slowed from the good start it got off to in the first quarter of 2012. The broker notes that much of the slowdown is due to a cooling in vehicle sales after hot numbers 4Q 2011 and 1Q 2012 that beat even the most optimistic forecasts.
The broker sees at least one potential bright spot, which is housing related durables. Citi points out that these tend to follow single-family construction and recent signs are suggesting a pickup in this market in the 2H and beyond. In fact, the broker notes that positive signs are also starting to flow though to mortgage approvals now and aren’t just limited to construction data.
Still, Citi thinks US consumer spending outlook will remain fairly subdued over the balance of the year. Even the 2%- 2 .25% growth rate the broker is expecting (well below the 1Q run rate of 2.7%) still dependent upon the US avoiding a large European credit shock, or panic over the US fiscal outlook.
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