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Weekly Highlights

In a week where domestic equity markets sold off (down ~2.7%) and bond yields rose to recent highs (~2.40% on 10Y AGB) we were swamped with new company information. The recent change in bond yields is having an effect on a number of companies especially those with earnings or asset values linked to bond yields.

There is no greater evidence of this than in the Life Insurance sector. On Friday AMP announced a $668 million goodwill impairment which was primarily a result of changes to claims and lapse assumptions. The share price is down ~12% in two days but the risks for debt and hybrid investors are arguably neutral as a new reinsurance agreement with Munich Re (yet to be formalised) should allow for a ~$500 million capital release.

In the supermarket sector competition is high. Last week Wesfarmers released a disappointing first quarter update showing a significant weakening in Coles Food and Liquor sales (like for like sales were 1.8% – slowest rate since 2009). Whereas Woolworths delivered like for like sales growth of 0.7% for the quarter – the first positive in 18 months). Food price deflation (1.9% for Woolworths and 1.0% for Coles) managed to ease over the quarter but the price driven investment by Woolworths has been the key driver of the sales growth convergence. We now expect Coles to respond. Separately Bunnings is suffering from the ongoing sale of Masters stock into the market. For debt investors, this doesn’t really mean a lot in the scheme of things as Woolworths has limited debt stock available and decided to use predominantly use bank funding to improve financial flexibility.

The banking sector was also active. Last week ANZ pre-announced $360mn in specified charges to be taken in the FY16 results (click here) and this morning ANZ went into a trading halt as a result of the sale of Retail and Premium Wealth business in Asia to DBS Singapore. ANZ reports that the deal is accretive to Core Tier 1 equity (~0.15-0.20%) but this is likely to be over time and they will incur a loss on asset writedown. Full year results are due on Thursday and we expect more clarity at this point. These announcement are unlikely to help the already very wide range for earnings estimates.

Macquarie Group (MQG) reported another solid half year result (1H16) with net profit of $1.05 billion which was broadly inline with market consensus. The annuity style businesses continue to drive profit (37%) with Corporate Finance Division (22%) and Capital, Commodity and Financial Markets being the other major contributors. As always the balance sheet was busy and contributions from acquisitions (i.e. AWAS Portfolio and Esanda) increased the noise within the Corporate Finance Division. Not everything is perfect with net interest and trading income down 18% (vs pcp) and fee and commission income down ~21% (vs pcp). This weakness was offset by realised gains on sales of existing businesses (i.e. $601 million gain from sales in listed and unlisted investments in energy and commodity sectors), the $239 million sale of Macquarie Life Risk Business and a substantial decrease in provisions. These are all one-offs event which suggest the operating business are starting to exhibit signs of weakness.

The biggest news for the banking sector was an announcement this morning (click here) from Standard and Poor’s (S&P) which has downgraded the outlook on 25 Financial Institutions to negative. This includes AMP Bank, Macquarie Bank (and Group), Bank of Queensland, Bendigo and Adelaide Bank among others. This change is technical in nature but ultimately it stems from rising private sector debt and residential property prices. They believe there is an imbalance between the real economy and residential property prices (i.e. private sector debt to GDP increased from 118% in 2012 to 139% in June 2016). If this continues there is “risks of a sharp correction in property prices”. This scenario will ultimately lead to greater losses for the banks. In our view the agency is cautiously warning the banks of something the market is already very aware. However, it is important to understand that this rating risk is separate to the “government support” announcement earlier this year – which is why the major banks are already on watch negative. This new rating risk is more relevant for capital instrument investors as it could impact the Stand-Alone Credit Profile (“SACP) rating which is the benchmark used for these ratings. Overall, this rsik can be mitigated by appropriate provisioning against a potential property cycle downward swing.

Finally, Qantas reported a trading update this morning which the market did not like (down ~9% as we type). Underlying profit before tax is now expected to be $800 – 850 million (down on the previous year ~$920 million) for the full year and although costs are improving competition is hurting revenue internationally and domestic demand is benign. We remain confident that Qantas can maintain capital stability but we will cautiously watch the passenger statistic over the coming quarter to ensure they remain competitive.


Click below for Charts

Chart 1: Bloomberg AUSBond Composite Index (Monthly)

Chart 2: Bonds vs Equities 2015/2016 (Monthly)

Chart 3: Term Deposit Review – September