How to Play a Lower RBA Cash Rate
Lower forever?
Australia has delivered 25 years of robust growth built on good economic management, a commodities
super cycle and household leverage. However, these favourable trends have either peaked, or are under
threat from structural change from a slowdown in China’s growth model or a structural shift in domestic
economic drivers. With inflation lingering at multi decade lows and slower than expected transition from
mining related industries, the RBA remains under pressure to address the countries growth concerns and
trim the cash rate further.
Fiscally the economy remains constrained from a large budget deficit, placing the country’s AAA rating
under threat. Accordingly, some economists are now forecasting a terminal cash rate of 1.00%. These are
unchartered waters for the domestic economy, but with the change brings opportunity. assess which
sectors we believe will benefit most from both the structural shift in economic resources and a lower
domestic cash rate.
’s Top Sector Views:
Tourism
Is a major beneficiary of a lower AUD as global travellers find Australia a relatively more
attractive tourist destination.
Lower interest rates generally are not a strong catalyst for the gaming sector as a
whole. However, if lower interest rates successfully lift GDP and lead to higher
disposable income in the market, there could be a slight positive as more money is spent
on gambling. Within the gaming sector, Crown has the biggest offshore exposure.
Crown has a 27.4% stake in MPEL, so Crown would likely also benefit from a
depreciation in AUDUSD.
Sydney Airports (SYD.AX)
SYD owns and operates Sydney Airport which is the 11th largest airport in the Asia
Pacific region and 31st in the world by passenger numbers. It consists of two main
business units which are 1) Aviation (Sydney Airport) and 2) Commercial Opportunities.
The majority of revenuceis generated from the aviation side of the business (49%), with
the balance consisitng of retail (22%), carparking/transport (12%) and property (17%).
SYD holds the dominant share of the international passenger market with approximately 41% of total international passenger numbers into and from Australia in 2014. The business is focused on optimising operating performance and upgrading the airport to accommodate passenger growth and maximise revenue opportunities.
Key medium-term opportunities involve retail expansion, growing the car park
business, catering to rising Asian tourism and the completion of a 2nd major Sydney
airport in Badgerys Creek.
Crown Resorts (CWN.AX)
Crown Resorts is an international gaming company. It includes businesses and
investments in the integrated resort and entertainment sectors in Australia and Macau,
and wholly-owns and operates a high-end casino in the United Kingdom.
We believe that both tourism and in particular the gaming industry are set to receive a
material boost over the near term. Specifically, the falling AUD will attract high visitor numbers which should translate to improved revenues for CWN. Furthermore, due to regulatory changes in Macau, we are anticipating a further uplift as Chinese gamblers seek alternatives to Macau gaming. Crown is well positioned for these macro changes as it differentiates its self from its domestic competitors by its offerings as a market leader in capturing both Asian and VIP gamers.
Mantra Group (MTR.AX)
Mantra is the second largest accommodation operator in Australia. It has 11,000 rooms in more than 110 properties in Australia, New Zealand and Bali in its accommodation portfolio ranging from luxury resorts to serviced apartments in CBD and leisure destinations.
Mantra offers investors a long-term and scalable entry into what we believe will be continued growth for the Australian tourism industry. Mantra Group benefits from an expectation of strong growth from inbound visitations, particularly from China. This comes at a time where returns are enhanced from increased demand from other source countries thanks to a more competitive Australian dollar, with further boosts from a domestic travel segment switching to ‘staycation’ activities.
Agriculture
Given that Australia is a major net exporter of agricultural goods and services, a cut to
the cash rate and a corresponding fall in the exchange rate should be seen as a major
advantage for the sector.
We expect producers to benefit from both a transaction benefit (Australian goods are
relatively cheaper to the rest of the world with a lower AUD) and a translation gain
(Australian producers are paid in offshore currencies which will be worth relatively more
if the AUD falls).
Treasury Wine Estates (TWE.AX)
Treasury Wine Estates Limited is a wine manufacturer and distributor catering to both the premium and commercial segments of the market. The Company’s principal activities are grape growing and sourcing; wine production and packaging, and wine marketing and distribution. It operates in a number of geographical locations including Australia and New Zealand; Europe, Middle East and Africa; Americas, and Asia. The Company’s brands include Commercial, Masstige and Luxury wine brands, such as
Penfolds, Beringer, Lindeman’s, Wolf Blass and Rosemount. The Company owns and leases approximately 9,424 planted hectares of vineyards in Australia and New Zealand.
TWE is a major beneficiary of a lower AUD with ~75% of earnings being derived offshore. We estimate a 1 cent fall in either the AUDUSD or the AUDGBP contributes approximately A$2mn to group EBIT. TWE achieves this in two ways. (1) Translation benefits – a lower A$ results in higher A$ earnings when TWE’s offshore earnings are translated; and (2) transaction benefits – a lower A$ relative to the US$ and GBP
improves TWE’s competitive position in offshore markets. We maintain our bearish stance on the AUD, hence TWE should continue to benefit from a lower currency over the medium term.
Treasury Wine is well placed to capitalise on rising per capita consumption of wine across both developed and developing markets. It has a strong brand which enables it
to lever the trend towards high-value branded wine. A number of attractive opportunities remain for the company given the Free Trade Agreements signed with Korea, Japan and China.
Healthcare
Lower cash rates will likely mean that healthcare stocks with perceived excess growth
and safety continue to trade at or near record valuations. USD earners are likely to see
A$ earnings upgrades. We think the sector overall should do well – all stocks offer
defensive volume growth.
CSL Limited (CSL.AX )
CSL Limited is a biopharmaceutical company that researches, develops, manufactures and markets biotherapies to treat and prevent serious and rare medical conditions such as haemophilia and immune diseases. The principal activities of the Company include research, development, manufacture, marketing and distribution of biopharmaceutical and allied products.
CSL is involved in the Healthcare industry, a sector we are positively positioned towards across our portfolios. We like healthcare as a multi-year dynamic as it receives a tailwind from an aging population as the baby boomer generation head into retirement, boosted demand for aged care related products in particular.
Another key attraction of CSL is that it is an offshore earner, and its earnings in
Australian dollar terms should generally benefit from the further weakness we forecast
in the Australian dollar. CSL is a global facing company, with major facilities in Australia,
Germany, Switzerland, United Kingdom and the U.S., CSL has more than 14,000
employees working in over 30 countries.
Aveo Group (AOG.AX )
Aveo Group offers premium retirement living solutions that allow the elderly to release
capital from the family home and obtain care services. We expect the addressable
market to increase substantially because of the ageing population and see potential
for the penetration rate of over 75’s to increase to be more in line with that of New
Zealand and the US.
Aveo’s significant development pipeline and capability allow the company to benefit
from this increase in demand and positions Aveo Group to increase its market share
(from 7% currently).
Healthscope Limited (HSO.AX)
Healthscope (HSO) is Australia’s second largest private hospital group. The company
operates hospitals (approx. 4,500 beds), medical clinics and clinical labs in Australia,
New Zealand and Southeast Asia.
HSO offers investors exposure to the aging baby boomer population. Current
projections indicate that there will be insufficient medical resources to cater for this
growing demographic. However, HSO is well positioned to capture the benefits from
this short fall.
It is currently undertaking an ambitious expansion plan in order to step up its hospital
capacity and absorb this extra demand. Although, HSO is not cheap on a valuation
basis, it is significantly more attractive than its main competitor Ramsey Health Care
REITS
A lower cash rate should support REIT’s outperformance given: (1) high distribution
yields will remain relatively compelling; and (2) earnings growth and certainty will also
remain relatively attractive given the cost of debt and economic concerns.
GHC fits both the REIT and the healthcare thematics as it invests in stable healthcare
relate property assets. We think it offers a good way to leverage off improvements in
both sectors.
Under a 1% cash rate scenario foreign earners are likely to benefit given potential AUD
weakening and exposure to relatively higher growth markets. WFD is the largest USD
beneficiary and combined with a strong earnings profile driven by near-term
development completions it remains well placed to outperform (see below in offshore
revenue earners for further details).
Generation Healthcare REIT (GHC.AX)
Australia’s only ASX-listed real estate investment trust that invests exclusively in
healthcare property. The portfolio of 17 properties includes hospitals, medical centres,
laboratories, residential aged care facilities and other purpose-built healthcare
facilities. Generation Healthcare partners with high quality healthcare tenants with
well diversified income streams. The company has total assets under management of
$407 million with investments located in Victoria, New South Wales and Queensland.
The company focuses on owning quality healthcare-related real estate over the long
term that will add value and provide strong risk adjusted returns for its investors.
expects to observe a structural pick-up in demand for aged care goods & services
as baby boomers near retirement. Retirement village space, private hospitals, aged
care providers and funeral services and all likely to observe strong growth rates and
demand picks up for the services.
In addition, healthcare property has low volatility and is typically less cyclical than other
property classes. This provides attractive exposure for investors seeking stable income
and exposure to the property sector.
Offshore Revenue Earners
Offshore earners are Direct beneficiary of a lower AUD via translation gains. (Australian
producers are paid in offshore currencies which will be worth relatively more if the AUD
falls).
Westfield Corporation (WFD.AX)
WFD is a global retail property group with interests in shopping centres in the US, the
UK and Europe. It is engaged in the ownership, development, design, construction,
asset management, leasing and marketing activities with respect its retail focused
property portfolio.
Whilst 100% of its assets and income are generated offshore, it listed on the ASX and
therefore is a direct beneficiary of a lower AUD (via a translation gain). Given
Westfield’s exposures it should benefit from a lower AUDUSD and lower AUDGBP
exchange rate.
Westfield It was created as part of the global restructure of the Westfield brand in
2014. Westfield Corp is now home to the brand’s U.S. and U.K. stores while Scentre
Group Ltd (SCG.AX) is the owner and operator of the brand’s Australian and New
Zealand centres.
We like WFD for its USD and GBP exposure, property fundamentals and M&A
optionality. We believe the company has a strong brand image and is set to benefit
from their ambitious growth pipeline. It presently has 34 shopping centres and almost
6,500 retail outlets. WFD has planned a further US$11.8bn of spending for its growth
pipeline to further enhance the quality and prominence of its portfolio.
It has ample balance sheet capacity to undertake these ambitious developments with
$1.2b of cash at $3.3b of undrawn debt facilities available to it. The company’s financial
gearing stands at 33% (Net debt / Tangible assets or 30% debt to EV & interest coverage
of 4.7 times). Total development capex over the next 5 years is expected to be circa
US$5b and would see gearing increase to 40% and still in an acceptable range, in our
opinion.
Banking
Lower cash rates reinforce the appeal of the banks’ circa 6% dividend yield. However,
they also lead to more downward pressure on net interest margins and highlight the
risk of higher than forecast loan losses from a weaker economic outlook.
A reduction in the cash rate would put downward pressure on net interest margins. It
is therefore unclear the direct nature of how the sector as a whole will perform.
However, our preferred play in the banking space is BOQ.
Bank of Queensland Limited (BOQ.AX)
BOQ is an Australia-based entity engaged in retail banking, leasing finance and
insurance products. The Bank operates in two segments: banking and insurance.
Banking segment services include retail banking, commercial, personal, small business
loans, equipment, debtor finance, treasury, savings and transaction accounts.
Insurance segment services include consumer credit insurance, life insurance,
accidental death insurance, funeral insurance and motor vehicle gap insurance. BOQ’s
operations comprise: Banking, BOQ Finance and BOQ Specialist.
While a challenging operating environment weighs on EPS and dividend growth
prospects, BOQ is our preferred Australian bank given re-pricing benefits, a pipeline of
cost savings, de-risking and a relatively strong capital position
Background to lower Rates:
Unemployment
Australian labour market data in April printed a relatively low unemployment rate
(unchanged at 5.7%), but underlying trends point to a weaker outlook. There has now
been a net loss of approximately 50k full-time jobs in the last four months, with slowing
jobs momentum in trend terms, and intensifying contraction in hours worked.
While growth in employment (of +10.8k) in April was broadly in line with consensus
expectations (+12k), the composition of jobs growth remains skewed to part-timers
(+20.2k, +4.5%yoy) at the expense of full-time positions (-9.3k, +1.0%yoy). There has
now been a net loss of 50k full-time positions over the past four months.
Furthermore, hours worked have fallen sharply for a consecutive month in April, by –
1.1%mom, to be lower over the year (-0.5%yoy) for the first time since May 2013.
Evidently, while the unemployment rate remains relatively low, digging deeper
reveals worrying signs in the underlying economy. Both full time employment and
hours worked are falling adding pressure to the earnings power of the wider
economy.
Inflation – CPI
Headline CPI fell to 1.3% YoY versus a market consensus 1.7%. While the market
expected some impact from lower petrol prices, the surprise came through in weak
underlying measures, with the average dropping to 1.5% YoY (record low since 1982)
and consensus at 2.0%.
Clothing and Footwear fell to -0.8% YoY, Housing softened further to 1.7% (with Rents
at 0.9%), Communication fell to -6.4%, while Recreation fell to -0.1% YoY. Education, a
sector that typically sees high rates of inflation, fell from 5.5% to 3.3%.
Underlying inflation indicators are now at risk of falling below the RBA’s target band
of 2-3%. Given the global outlook on inflation, believes that the RBA will be
extremely mindful of how difficult it is to generate inflation in a stalling economy.
Fiscal Policy Outlook:
The Budget update flagged a further deterioration in the deficit over previous
estimates as falling commodity prices coupled with lower growth assumptions weigh
on government tax revenue. In our view, ongoing fiscal headwinds and rising net debt
suggests the risk of a credit ratings downgrade are underappreciated, and
consequently Australia’s AAA rating is at risk.