Consumers beat the odds, keep prices afloat

Australian consumers’ relentless discretionary spending has proven them more resilient than originally expected amid inflation and interest rate hikes, according to Maple-Brown Abbott.

Dougal Maple-Brown, Head of Australian Value Equities, said the manager sees “merit in selective allocations” to banks and general insurers, despite stocks in the industrial sector managing to hang on by a thread.

“We favour the banks – also beneficiaries of higher rates – with our positive view premised on two attributes: inexpensive valuations and sensible earnings forecasts,” Maple-Brown said.

“While return on equity will be lower for the banks today than in prior years, largely due to increased capital requirements (and thus improved resilience), it appears to us that bank share prices are already discounting tough conditions.

“The second attraction of the banks is that earnings forecasts appear ’sensible’, particularly when compared to some of the ‘high flying’ industrial stocks. Of course, almost all forecasts will be ’wrong’ but for the banks, the market expects low single digit credit growth, ongoing Net Interest Margin (or NIM) compression, modest expense growth and increasing credit charges. Our forecasts are similar.

“This produces a relatively flat earnings profile; however, we forecast most banks can still generate a satisfactory total return to investors, largely driven by high single digit gross dividend yields (including franking). Further upside exists if our credit charges prove too pessimistic, which has been the case so far, and the potential for modest capital management.

“In addition to expensive multiples, many of the favoured industrial stocks were also trading on elevated earnings and / or elevated earnings expectations. Over the course of the most recent reporting season, and indeed the ’confession’ season that now precedes it under the continuous disclosure regime, some of these stocks started to unravel.

“In most cases it was the inability of the company to deliver the lofty earnings expectations that the market demanded to essentially justify the share price.”

Maple-Brown said the general insurers are also poised to benefit from rising interest rates.

“They collect premiums upfront, invest the so-called ’free float’ before ultimately paying out claims. As the free float is generally invested in cash and short-dated fixed interest, returns improve as interest rates rise.

“While the general insurers are also impacted by climate change, via increased claims and re-insurance costs, the recent Bureau of Meteorology announcement of the arrival of an El Nino climate pattern should help reduce the incidence of costly natural disasters this summer in Australia. We remain favorably disposed to the general insurers.

“Market commentators continue to focus on the macroeconomic environment both here and overseas, and a chorus of bears continue to recite their recessionary lines. As bottom-up stock pickers we are alert to the broader environment but remain focused on in-depth analysis at the stock level and structuring our portfolios to take advantage of emerging pockets of longer-term value.”