Australia’s economy is slowing quickly, and the profitability of domestically focused companies is under significant pressure. However, companies in high-growth sectors such as technology and health could continue to do well, as well as those exporting to higher-growth economies.
The Australian economy expanded just 0.4 per cent in the March quarter, to give growth of 1.8 per cent over the year. That was the slowest growth in almost 10 years. Domestic consumption was weak as households spent less given high debt levels and low wages growth.
Yet despite a domestic economic slowdown, some sectors will do better than others, either given the defensive nature of their earnings or their export focus.
In the healthcare sector, CSL, ResMed and Cochlear have significant global markets for their products. An ageing population in developed countries is helping to propel demand for their products given increased needs for healthcare. The sector is defensive too; we need medicine and healthcare products whether or not the economy is doing well. Healthcare companies often boast government contracts that ensure ongoing earnings for their products, even during a downturn. So their earnings are relatively robust.
The technology sector too is likely to continue to do well. Demand for technological products and services is growing rapidly and is not likely to slow down much, even during a cyclical downturn. As a result, businesses like Appen and the REA Group will likely continue to reap earnings growth. Appen, in particular, is linked to the huge growth in artificial intelligence and machine learning, for which it provides datasets.
The big miners are also doing well given a surge in the iron ore prices. This month, iron ore went above US$100 a tonne for the first time in five years, thanks to concerns about supply. BHP Billiton, Rio Tinto and Fortescue Metals Group have all risen too as their earnings will increase with the higher iron ore price.
Other companies that could do well even if the Australian economy continues to slow include exporters of consumer products like the a2 Milk Company and Treasury Wine Estates. Both companies export significantly to China, which is enjoying much greater economic growth than Australia. The rapid urbanisation of China’s economy is leading to strong ongoing demand for consumer goods. Even if the US-China trade war flares up more, China’s middle class will keep growing and consume more.
Another sector that could fare better during a downturn is infrastructure. Companies like AGL and Alinta enjoy reliable earnings from their electricity businesses, despite some margin pressure from competition. As provider of an essential service, earnings should prove defensive and any increases in retail energy prices will underpin profit growth.
In contrast, the domestic focused financial sector faces some of the greatest earnings hurdles. The housing market downturn, especially in Australia’s biggest cities, Sydney and Melbourne, will weigh heavily on demand for mortgages from investors and owner-occupiers, which in turn will weigh heavily on the big banks’ mortgage earnings. Very high household debt and low wages growth will weigh on demand for personal loans. So, overall, the big banks face relatively low earnings growth, between 2 per cent and 3 per cent in the year ahead.
One standout in the financial sector is the export-focused Macquarie Bank. Much of its earnings come from its offshore operations, so it won’t be as exposed to the slowing domestic economy as the big four banks.
Retailers will suffer with high levels of household debt. For the last four years, housing debt has grown faster than disposable income. While housing debt was 62.4 per cent of household annual disposable income in the September quarter of 1998, it was 1.48 times the annual household disposable income 20 years later, ABS data shows.
As a result of such high debt levels, some home owners are reconsidering whether they will undertake renovations or spend money on household items such as furniture and white goods. That will weigh on the retailers, and the housing downturn will also reduce demand for construction materials, which will in turn impact on the builders.
Michael Kodari, executive chairman, Kodari Enterprises
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