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Weekly market update - 17th of August 2021

Written and accurate as at: Aug 17, 2021 Current Stats & Facts


THE FIRST week of reporting season was largely positive, helping Australian equities outperform other markets.

At this point, there seems to be surprisingly low levels of concern about the impact of local lockdowns. The S&P/ASX 300 gained 1.33% last week, and the S&P 500 was up 0.75%.

Things were quiet on the macro front. US inflation data was strong — but in line with expectations. The focus remains on Delta and the potential implications for economic growth.

Bond yields were stable, and there was a small rotation away from growth stocks.

COVID outlook for Australia

The market is grappling with two aspects of the domestic Covid outbreak.

First, the risk that Melbourne also lapses into extended lockdown. This would mean effectively half the nation’s economy was affected by restrictions.

The second issue is speculation on the timing of an easing in restrictions related to vaccine penetration.

Vaccination rates continue to rise from 0.74% of the population per day last week to 0.87% now.

NSW is running at more than 1% daily. We could see the rest of the nation reach this point in September as greater supply becomes available. This would be in line with the peak rates of vaccination in other regions.

Simple extrapolation of 1% daily gets us to 70% of the population vaccinated in the first week of October and 80% two weeks later.

The impact of restrictions — combined with the effect vaccinations have on transmission — suggests we could see a reasonable degree of re-opening in October or November.

The question is whether governments will be willing to tolerate a material number of Covid cases, assuming hospital systems can handle the pressure.

The link between vaccinations and lower severity of Delta cases — and hence less pressure on medical systems — remains evident in the UK and Israel.

The degree of hospitalisations in these countries equates to 2000 to 2600 hospital patients in Australia, compared to the sub-400 level we now see. This highlights the policy dilemma we face.

Covid outlook for the US

In the US, case numbers and hospitalisations continue to rise.

This reflects a disparity in vaccination rates among the States since fewer than 2% of admissions are fully vaccinated. It also reflects a less systematic approach to protecting vulnerable Americans.

The question is whether the US will follow the Indian and UK path. If so, cases should peak in the next two to three weeks.

This is important given the pressure building on hospital capacity. About a quarter of Americans live in areas where ICU occupancy is running higher than 85%.

Covid outlook for China

The situation in China appears to be stabilising. Seventeen provinces have reported outbreaks — the same as last week — and reported cases are falling.

However, the hard measures used to clamp down on the outbreak have come at an economical cost.

The Chinese port of Ningbo-Zhoushan — the world’s biggest by bulk commodity volume — has been largely closed since August 11. Containers are now re-routed through Shanghai, creating greater global supply chain delays. (Ningbo-Zhoushan is the world’s third-busiest container port).

Beijing’s policy response will be important to watch.

Short-term measures include permit renewals for coal mines and extra steel capacity. Priority is placed on supporting activity and economic growth even though the tools are at odds with longer-term policy objectives of more balanced and greener growth.

Economic outlook

There are clear signs that Delta is starting to weigh on business and consumer confidence in the US. Surveys on both measures have been turned down recently.

The US CPI print showed year-on-year inflation remains above 5%. While high, this is the first time it did not exceed consensus expectations in recent months.

This signals that some drivers of recent inflation — such as used auto prices — are starting to recede.

On the other hand, areas such as shelter — which may drive more persistent inflation — are starting to pick up.

Market highlights

Concerns over slowing economic growth are reflected in bond yields (which remain well supported) and softness in commodities.

There was an unusual “flash crash” in gold last Monday when a large seller hit the market during an illiquid Asian time zone. Gold fell 4% before bouncing off the US$1680/ounce support level. This reinforces current scepticism in the metal.

Australian equities outperformed global indices last week after a decent start to reporting season.

Broadly, we see better earnings and higher distributions than expected. Most importantly, a lack of excessive caution among companies regarding the current economic outlook and lockdowns is reassuring the market.

Gold stocks were generally weak following price volatility. Northern Star (NST, -6.5%) was the worst performer in the S&P/ASX 300. Evolution (EVN) was down 4.9%.

REA Group (REA, -6.1%) delivered a reasonable result, though the market focused on management’s note that Sydney listings were down 22% in July due to lockdowns. The fact that lockdowns saw 40-50% falls in Melbourne listings last year shows the industry is getting better at managing this issue.

REA emphasised how quickly the market has consistently bounced back from previous lockdowns. The property website has several longer-term growth opportunities, including data and insight services and offshore ventures in India and the US.

Transurban’s (TCL, -5.8%) revelation of a $3.3 billion cost blow-out on Melbourne’s West Gate project — off an initial cost base of $6.7 billion — disappointed the market. The toll road operator conceded it would have to bear some of the pain in covering these costs to resolve the issue. This was despite claiming that the blame lies with the government and contractor.

The market is also wary about the impact of lockdowns on traffic volumes, though this has little impact on longer-term valuation. TCL may need to raise capital if it successfully buys out the remainder of the Westconnex project.

QBE (QBE, +12.1%) was the best performer on the ASX 100 last week. It delivered its first well-received result for some time. Insurance premium growth is driving strong revenue momentum. Costs remain under control, supporting an earnings recovery. QBE is attractively valued in this light — well below historical relative valuations — which helped drive a strong stock price response.

Elsewhere in insurance, we saw results from Suncorp (SUN, +8.4%) and IAG (IAG, +8.8%). SUN was enjoying revenue momentum and flagged a constructive outlook for insurance margins. This allows strong capital return, with a payout ratio at the top end of expectations, a special dividend and a market buyback.

IAG’s result was less compelling, having pre-announced. It is demonstrating lower revenue growth and less clear cut margin improvement than peers. Nevertheless, the stock reaction reflects more confidence in the insurance sector.

Downer’s (DOW, +12%) result was good. Free cash flow was strong, and the company is buying back stock. Markets fears around wage pressure and the impact of lockdowns largely failed to materialise. DOW has successfully shifted from a capital-intensive model with unpredictable earnings and large exposure to mining service contracts to a more predictable urban services business with lower capital intensity. We expect this to improve the valuation rating over time.

James Hardie’s (JHX, +6.2%) result for 1Q FY22 demonstrated how a strong, well-managed franchise operating with cyclical tailwinds could deliver more operational leverage than the market expects.

Combining a supportive cycle, higher pricing, a more favourable product mix, and gains in market share saw JHX grow revenue 21% versus the same quarter in FY19. Management guided to 20% revenue growth for the full financial year.

The longer-term outlook is positive. There is an emphasis on gaining share in the home remodelling market in regions such as the northeast US, where JHX has not previously done.

Telstra (TLS, +4.2%) was largely in line with expectations. The Network Applications and Solutions (NAS) division was slightly disappointing. But the clear message was that the rebasing of earnings due to NBN was over, and earnings were now growing.

Mobile is key. It grew 18% in the second half, with average revenues per user increasing. This should continue to flow through, as will more cost-out. Further detail is expected in a September Investor Day. The dividend looks underpinned and may grow. TLS is returning some proceeds of their asset sales via buy-back.

Elsewhere Commonwealth Bank (CBA, +0.3%) beat the market’s earnings expectations, largely due to lower provisioning for bad debts. It is performing better than the other big banks in loan growth, particularly in the small business sector.

Overall this did not translate into much growth in revenue or pre-provision profits due to margins and higher costs as the company invested in its digital shift. A key area of debate is whether this is an opportunity to differentiate itself from the other banks or more a defensive move in response to competition from other payers.

CBA’s outlook for margins was subdued, which weighed on the stock. On the plus side, it announced a $6 billion buy-back and flagged no significant concerns from current lockdowns. CBA remains on a punchy valuation despite limited growth opportunities. We continue to prefer other names in the financials space.

National Australia Bank (NAB, +3.8%) provided a quarterly update. There was little new information, but cash earnings were running higher than the market expected, and margins remained stable. Costs and impairments were both a bit lower than expected.

Goodman Group (GMG, -3.1%) grew EPS 14% but disappointed a market looking for an upgrade to FY22’s guidance of 10% earnings growth. It continues to do well operationally, and the development pipeline is strong, as are assets under management.

A fall in cap rates has revalued their portfolio upwards. This means an upgrade may only be a matter of time. However, a valuation over 30x P/E is factoring in a lot of good news.

Finally, AGL (AGL, +0.3%) reminded the market of the challenges it faces, with earnings guidance for FY22 coming in 15% lower than market expectations. The big issue is the company’s path out of trouble, given earnings declines and excess debt.

A demerger remains planned, but it is clear the company is under-capitalised given the pressure on earnings and remediation costs of future plant closures. Ultimately this will need some form of policy from the government to help underwrite the outlook, but we have no certainty this will occur.

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