Long-term debt pain starting to hit home

The Australian 12:00am February 23, 2019

Roger Montgomery

The half-year reporting season on the ASX is well under way and a few themes are emerging that suggest the cautiousness with which we approached 2019 was not misplaced.

Indeed, the reason for our caution may have only just begun.

By way of background, Australian households have amassed a record level of debt to income, as many countries have, over the past 30 years.

The reason is pretty straightforward — declining interest rates, three decades of declines.

The difference is that Australia’s rate of increase in the debt-to-income measure has been much steeper. Elsewhere in the world, where the rental yields are more attractive, sophisticated corporate investors own more of the rental stock. Here in Australia, where the net yields are negative, the majority of the rental stock is owned by less sophisticated “households”.

The consequences of the nation’s property portfolio being owned by highly leveraged households will inevitably be more volatility in the price of that asset class as well as more volatility in the sectors that must compete for the household’s wallet.

Nationwide, Mercedes sales fell 43 per cent year-on-year in November 2018 alone and Ford sales fell 41 per cent. Retail fashion sales slumped 3.8 per cent in January and, while foot traffic plunged at the start of the year, Westpac reported that consumer confidence had “evaporated”.

Big-ticket items are the first to see the tide go out and during reporting season we haven’t been surprised to see weakness in the results of car dealers Automotive Holdings and Autosports Group. A strong historical correlation is reported to exist between housing activity as measured by turnover and car sales.

Moreover, hot coals have been heaped on the weakening new car sales trends by the Sydney hail storms and quarantine’s fumigation of imported vehicles for stink bugs, which delayed the delivery of tens of thousands of vehicles nationwide.

Even before yesterday’s result, Automotive Holdings was significantly exposed to slowing retail, deteriorating consumer and housing trends, and last year its AGM trading update was weaker than expected, with full-year 2019 guidance missing already reduced consensus expectations.

This year Automotive Holdings has already announced $226 million of non-cash impairments, which comprised $147m for the impairment of the carrying value of the retail franchises, goodwill and intangibles as a consequence of acquisitions that have not met expectations.

In the building game, the decline in development and demolition activity has hit Villaworld, AV Jennings and waste company Bingo Industries among others. This week Bingo shares plunged 50 per cent as the company surprised the market with a forecast of flat growth in earnings, down from prior guidance of 15-20 per cent growth. Understandably, the downgrade was swiftly followed by the earnings-multiple derating after analysts pared their earnings forecasts out to 2021.

Bingo’s exposure to the residential construction industry and an inability to pass on price increases are the reasons for the shock, with the company noting “a faster than anticipated softening in multi-dwelling residential construction activity across Bingo’s key markets in NSW and Victoria”. But it shouldn’t have been a surprise. The trends affecting Bingo remain somewhat entrenched, and weaker activity than that which affected this year’s results appears to be on the horizon.

Indoor and outdoor lighting and fan retailer Beacon Lighting is likely to experience similar trends. In its half-year results, the company reported overall sales growth of 4.8 per cent but it opened three new stores, closed one and converted another, meaning its like-for-like sales growth (excluding “impacted stores” — those 15 stores that were cannibalised by a store opening land grab) was just 0.5 per cent. Beacon noted that like-for-like sales growth remained volatile with December positive but January negative, and it said second-half trading was ­expected to be “unpredictable”.

Over at home builders AV Jennings and Villaworld, the picture is equally bleak. AV Jennings noted weaker economic and housing conditions contributed to declining sales and margins.

The company reported first-half revenue of $113m, down almost 40 per cent. Net profit of $2.2m was down 90 per cent from the $22.4m reported in the previous corresponding period.

In December home builder Villaworld downgraded its earnings guidance, stating it would not achieve 2019 guidance for net profit of about $40m. With rapidly deteriorating conditions, the royal commission and ALP proposals to change negative gearing terms, the company refrained from providing updated guidance. Fast forward to the present and Villaworld noted that conditions worsened in the December quarter and lot sales were more than a third lower than the ­December quarter 2017.

Importantly, analysts don’t appear to have grasped the seriousness of the deleveraging phase we appear to have entered. One analyst covering builders wrote they still believe the weakness could last “another few months”, without explaining what will change between now and May. The presence of hope, but the absence of a positive catalyst, suggests further downgrades remain likely.

The skew towards downgrades is also reflected in the EPS revision momentum of the market. For the ASX 200, since January 2018, revisions to 2019 EPS estimates have been better than average, mostly reflecting higher commodity ­prices. Take commodities out and EPS revisions for financials are towards the bottom of their 15-year range and for industrials excluding financials EPS revisions have weakened from well above average to modestly below average. I am reminded of The Carpenters’ song We’ve Only Just Begun.