Income Report / Income Portfolio; Are we concerned about property prices? (GMA, CBA, HVN, NCK, GTY)

By Market Matters 13 June 18

Income Portfolio; Are we concerned about property prices? (GMA, CBA, HVN, NCK, GTY)

Market Matters Income Report 13th June 2018

The Australian housing market has suddenly come under significant pressure according to recent data and the threat of a housing crash has risen markedly according to some. Yesterday we saw another print of more bearish property data with housing finance down 1.4% in April, the fifth straight monthly drop and the longest stretch of declines since September 2008, when Lehman Brothers collapsed and a month before the Reserve Bank of Australia cut rates by 1%. Sydney seems to be in the firing line (ouch!) where prices slid 4.2% in May from a year earlier. House prices are clearly coming off the boil with the obvious question, should we be alert or alarmed and what is the likely implication for stocks?

Source; Bloomberg

In terms of the MM Income Portfolio, it was up 0.57% over the past week while the ASX200 added 0.99%. Since inception (5/7/17), the portfolio is up 5.22% versus its benchmark (RBA + 4%)  which equates to 5.15%. Cash rose 1% to 6.5%, however a buy order is in the market to purchase 3% in IGL – now with a limit of $2.28. To view all past activity on the Income Portfolio – click here

Before we move onto the core of today’s report I wanted to touch on a recent underperformer of the MM Income Portfolio – Genworth Mortgage (GMA). Yesterday’s +7.3% surge by GMA has reduced our paper loss back under 5%, the question is do we cut and run now the stock has bounced almost 20%? The simple answer is no, in fact we would be tempted buyers if we had no position. The dividend clearly remains attractive and we believe the worst is behind GMA.

Also, remember GMA has high amounts of excess capital which means share buy-backs and other capital management initiatives, which is why we hold it. The current $96.5m  buy back has only really commenced which clearly helps the share price.

  • Technically GMA remains a buy targeting $3.30 with relatively close stops below $2.50.

Genworth Mortgage (GMA) Chart

Are we concerned about property prices?

A headline grabbing stat for Sydney Property prices down -4.2% in May YoY to take the gong as the weakest Capital City in Australia. Other capital cities were actually up as the above table shows while the drop in Sydney dragged the national aggregate into the red by -1.1% YoY. These numbers are grabbing a lot of attention, specifically in Sydney however its always worth putting short term data into context relative to longer term trends. Sydney house prices have exploded over the past 20+ years, with the recent data showing a decline from 180.5 on the index (below) down to 168.90. (The chart below is quarterly so prints quarter end – the 168.9 print is end of May). This is showing a clear drop but trends rarely move in a straight line, particularly when human emotion is a factor!

Sydney House Prices Chart

Looking nationally the trend is similar, however the magnitude of the growth is substantially lower. We are seeing signs that the trend has peaked which is understandable given interest rates are now at record lows and the next move will likely be up, however clearly the last 5 years has been an incredibly positive period for home owners in Australia. This has created a significant disparity between those that own and those that don’t – a political problem for both parties leading into the next election. 

Australia House Price Index  Chart

Our friends at www.livewire.com posted an interesting article this morning calling the end to the 25 year bull market in property prices. That’s a big call and from the substance of the article it seems a little sensationalist, however some good insight nonetheless from a number of contributors. Here’s a very summarised version of what they think;  

Shane Oliver, Chief Economist, AMP Capital; Our base case, with a 70% probability, is for prices in Sydney and Melbourne to fall another 4% or so this year, another 5% next year and around 2-3% in 2020. Overall, Sydney and Melbourne are likely to see a top to bottom fall of around 15% spread out to 2020, but for national average prices the top to bottom fall is likely to be around 5%.

Alex Joiner, Chief Economist, IFM Investors;  I expect somewhere in the range of 3 - 5% per year, but for an extended period.

Pete Wargent, Director, Wargent Advisory; Our base case for Sydney is a peak to trough decline of about 10 per cent before the market stabilises. Some markets, including houses in outer western Sydney could experience a larger drawdown. If the ALP wins the next federal election and implements proposed reforms to negative gearing and the capital gains tax discounts, we see prices across the state down by a further 9 per cent for houses and 9 per cent for units.
In some sub-markets the impact will be more acute still.

A 10% correction nationally brings the market back to where it was in 2016. In terms of Sydney, a 10% drop from the end of May in addition to the 4.2% YoY decline we’ve already seen would bring the market back to where it was in 2015. Arguably  a healthy correction relative to the longer term trends, however it will create some pain at a time when household balance sheets remain stretched.

Without being property experts, at MM we think that Australian house prices will correct, but not crash – another 10% in Sydney would be excessive in our view but certainly within the realms of possibility. Property in areas where supply has not increased significantly as prices have risen will fare best.

Yesterday I attended a small ‘desk’ presentation with the CFO of Transurban (TCL) – Adam Watson. He provided good insight into their strategy (even though it’s a stock we remain bearish on) however it also served as a good reminder about the underlying dynamics that drive demand for things, like toll roads and property. Population growth is a key driver for both!

Adam showed the below chart which focusses on areas in which they hold toll roads. Sydney for instance is forecast to experience a 48% increase in its population in the 30 years from  2015 to  2045 - from 5 million  to over 7 million Sydney siders. Clearly a significant tailwind for property prices over time, after a short term correction it would seem.   

Just like the share market, corrections in asset prices are common, they’re healthy and above all, they create opportunity for the informed. While our focus remains on the share market, clearly a correction of the significant rally in house prices is a probability as interest rates bottom.  

What stock / sectors will feel pain?

Banks

The obvious conclusion is the banks - falling house prices will likely lead to a uptick in bad debts, however the pace of any house price decline plays into this, along with the cost of servicing debt (interest rates) and the ability to continue to service debt (being employed). While the concerns around Australian house prices have been in play for some time and international investors have been outright negative Australian banks as a consequence, further signs of price weakness would most likely lead to further falls in local banking shares – a theme we’re seeing today.  

We are currently buyers of bank shares into weakness.

CBA Chart

Retail  

Falling house prices may erode already fragile confidence, and Australian consumers will spend less on discretionary items - retailers will ultimately feel the pinch. We have Nick Scali (NCK) in the Income Portfolio currently sitting on a gain of ~20%. We continue to think this is a very good business trading at an attractive price, however we ask ourselves, would we buy a ‘retailer’ now, and the answer is a certain no - we are therefore considering selling NCK.

We touched on Harvey Norman (HVN) recently, interested by a good technical structure and of course an attractive valuation, however this is a retailer with property exposure and Gerry just might find himself in the vortex of a brewing storm.

We have no interest in buying retailers

Harvey Norman (HVN) Chart

Nick Scali (NCK) Chart

Developers / property stocks  

We wrote about property stocks last week, at the time removing Vicinity Centres (VCX) from the income portfolio. The sector had run strongly in recent weeks and we suggested it was once again ‘stretched’ after its recently rally. Today we’ve seen more corporate activity in the sector with a bid for Gateway Lifestyle (GTY) at a ~15% premium. GTY was another ‘cheap’ property play within our universe, similar to Vicinity Centres (VCX). Property stocks trading below NTA are ripe for takeovers in this current environment given there is still a wall of capital out there globally looking for a home which rings especially true for Sovereign Wealth Funds, Public/Private Pension Funds and Real Estate Private Equity firms that have ongoing redemption obligations.

We remain negative property overall, however holding stocks trading below NTA makes more sense than holding the more expensive ‘developers’.

Gateway Lifestyle (GTY) Chart

IVE Group (IGL) – we are now happy to add IVE Group (IGL) into the Income Portfolio at $2.28 or better.

IVE Group (IGL) Chart

Conclusion (s)

We are negative property however concerns of a crash are overblown
We are keen buyers of banks into further weakness, averaging existing positions
We have no interest in buying retailers and may take NCK out of the portfolio in the coming days

**Watch for alerts**

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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