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Is The Worst Still To Come For Australian And New Zealand Companies?

Australian and New Zealand companies will be hit on multiple fronts heading into 2021. S&P Global Ratings believes many companies will continue to incur significant damage from COVID containment measures, amid the weakest macroeconomic environment in decades. The June 2020 reporting season highlighted a significant drop in earnings across many Australian and New Zealand companies, albeit they remained largely within our expectations. What's more, COVID-19 has driven or accelerated structural trends in a number of sectors, such as discretionary retail, that will potentially wipe out chances of a full recovery for some companies.

We expect defaults to increase from a limited level so far. Two companies headlined defaults during the June half: Virgin Australia Holdings Ltd. and Speedcast International Ltd. According to Virgin's administrators, unsecured creditors are likely to recover only 9 cents to 13 cents on the dollar, in line with our recovery rating assessment of '5' on the company's unsecured bonds.

In our view, government stimulus measures will remain a key swing factor in the recovery. Measures such as the "JobKeeper" program in Australia are playing a pivotal role in maintaining employment and supporting economic activity. The recent extension of the JobKeeper program until the end of March 2021, albeit at a reduced rate, will continue to provide much-needed economic support in the coming months. Nonetheless, we believe that worsening credit quality and defaults in the small and medium enterprise (SME) sector are likely to accelerate as these support mechanisms are removed.

Our pool of rated Australian and New Zealand companies continues to have a materially negative bias (see chart).

Corporate profit guidance remains cautious or absent, given the evolving nature of the pandemic and the material macroeconomic fallout, with risks weighted to the downside. In contrast, however, company share prices are elevated and stock exchange indices are surging.

Chart 1

image

Reporting Season Was Not All Bad News

Winners of this reporting season were primarily confined to those with an exposure to nondiscretionary and online retailing (Coles Group Ltd., Woolworths Group Ltd., and Wesfarmers Ltd.) and certain commodity sectors. For supermarket and online retailers, sales have surged, tempered by cost increases as they adapt their business models to online retailing and implement COVID safety measures. Although we expect the sales spike to moderate over 2021, these companies' performance will remain robust in 2021 in our view, despite the challenging macroeconomic outlook.

Similarly, industries supporting online structural trends are continuing to thrive. Industrial REITs, such as Goodman Group and its managed REIT offspring, are riding the wave of demand for logistics services to support online consumption. Although Australian Postal Corp. has been struggling to keep up with buoyant parcel deliveries, online parcel demand should provide a key rating support against ongoing structural mail declines and a large fixed cost base.

In the commodities space, miners with exposure to iron ore (such as Fortescue Metals Group Ltd. and Mineral Resources Ltd.) and gold (Newcrest Mining Ltd.) are benefiting from a price boom. These are some of the few industries that are maintaining or expanding their large capital investment programs.

COVID Is Continuing To Drive Structural Change

Retail REITs, a traditional bastion of stability, are facing multiple threats to credit quality. These include the near-term effects of COVID containment measures on rental collection, and more importantly, an acceleration of structural shifts to online retail. Consequently, 50% of our rated retail REITs are on negative outlook, including Scentre Group, Australian Prime Property Fund Retail, GPT Wholesale Shopping Centre Fund, and QIC Shopping Centre Fund. Many landlords have also recorded large asset devaluations in response to forecast declining rentals on lease renewals and subdued tenant demand.

We expect COVID containment measures to continue dampening the credit quality of retail tenants and increase defaults, cutting rent collections and vacancy levels. Further, as retailers become more selective regarding their brick-and-mortar presence, the occupancy levels could compress for lesser quality regional and subregional shopping centers.

Office REITs are also facing longer-term structural strains from the move toward increasing work-from-home arrangements. We expect tenants to look for greater flexibility in leases as they reconsider their space requirements, reducing occupancy and rental growth over the medium term. These structural threats, as well as the cyclical challenges associated with a weaker economy, will remain a key rating focus for major office landlords, such as a Dexus and GPT Group, in fiscal 2021 and beyond.

Tabcorp Holdings Ltd. is also facing accelerating structural challenges in its retail wagering business. The company took a A$1.1 billion write-down on these assets. However, it has proactively stabilized its credit quality via a recent A$600 million equity raising.

Many Sectors To See Protracted Recovery

Airports face several significant uncertainties: government policies, opening of state borders, and the restart of international tourism. After passenger traffic falls of around 95% year on year over April to June 2020, three-quarters of rated airports are on negative outlook. We have downgraded three airports to date.

In our view, airports' fiscal 2021's performance will be weaker than fiscal 2020's. However, their strong liquidity positions should support this weak phase. Sydney Airport (rated entity Southern Cross Airports Corp. Holdings Ltd.) and Auckland International Airport Ltd. completed equity raisings to shore up liquidity and bolster their balance sheets. Meanwhile, Brisbane Airport Corp. Pty Ltd.'s recent debt issues have improved its liquidity position.

We expect a very slow recovery in air travel. International travel, in particular, is unlikely to return to pre-COVID levels until at least 2024.

By comparison, toll roads have been quicker to recover as mobility improved with the relaxation of lockdown measures in many states. Traffic levels on Transurban's toll roads in Sydney and Brisbane have moved toward 80% of pre-COVID levels. However, in Melbourne, the return to more stringent lockdowns has cut traffic on Transurban's Melbourne Citylink toll road to around 40% of pre-COVID levels.

Volumes at ports have been hit and could soften in fiscal 2021 due to weak economic conditions. However, ports' property portfolios provide some offset and should limit the effect on their credit profiles.

The casino sector has similarly been hit hard by containment measures. Crown Resorts Ltd. stood down 95% of its workforce and cut noncritical capital and operating expenditure to stem the cash burn. Further, suppliers to the casino industry, such as Aristocrat Leisure Ltd., remain under rating pressure as casinos reduce investment to preserve capital. We don't expect a recovery to pre COVID spending levels over the next two years.

In the utilities space, APA group (rated entity APT Pipelines Ltd.) is well positioned to maintain stable operations and pursue growth. In contrast, integrated utilities, such as Origin Energy Ltd. and AGL Energy Ltd., are facing some pressure due to consumer hardship support and industry-related changes. Residential demand has remained strong while industrial demand is recovering. The drop in wholesale prices will affect the earnings of integrated players and is likely to persist for the next two years, reducing the current headroom for rated entities over the next 12-24 months.

Certain sectors are also facing other non-COVID related challenges. The migration of the telecoms industry to the National Broadband Network (NBN) is continuing to compress the earnings of Telstra Corp. Ltd. and Singtel Optus Pty Ltd. Exacerbating the stress is intensifying competition across mobile and other non-fixed-line services.

Macroeconomic Weakness To Pressure Cyclicals

The longer-term macroeconomic fallout of COVID is likely to weigh heavily on a number of cyclical sectors in fiscal 2021. In particular, building material companies, such as CSR Ltd. and Boral Ltd., will face cyclically eroding demand. While CSR's credit quality is largely insulated by its robust balance sheet, the 'BBB' rating on Boral remains under significant downward pressure. Nonetheless, Boral's recently announced strategic review may provide some much-needed capital flexibility to relieve rating stress in fiscal 2021.

Oil prices remain close to cyclical lows, which is continuing to squeeze the revenues of Woodside Petroleum Ltd. and Santos Ltd. However, only Woodside is facing material downside rating pressure as it confronts difficult funding decisions associated with its large capital expenditure pipeline and potential investments. To date, Woodside and Santos have curtailed their 2020 investment plans by 40%-50% to counter the credit effect of lower oil prices. Woodside's recently announced proposal to increase its interest in the Sangomar field, Senegal, has increased rating pressure. Rating stability for Woodside is increasingly reliant on the company's ability to articulate and execute a credit-supportive funding program for its growth plans.

Other commodity sectors, such as coal, remain under significant price pain. Coronado Global Resources Inc. faces significant earnings strain and has had to undertake a heavily discounted equity raising to reduce debt. The squeeze on the coal sector could manifest in lower above-rail volumes for Aurizon Group (rated entities Aurizon Network Pty Ltd. and Aurizon Operations Ltd.) and Pacific National Holdings Pty Ltd. Our forecasts assume some reduction in fiscal 2021.

Environmental, social, and governance (ESG) factors are also playing an increasing role in capital allocation decisions in the mining sector. The sector is reducing capital access for new developments in industries such as thermal coal. ESG issues are also playing an increasingly important role in the social license to operate for mining companies, most recently highlighted by Rio Tinto PLC's destruction of ancient aboriginal caves at Juukan Gorge, Western Australia.

Related Research

Bulletins
  • Home Consumption Spike To Moderate After Surge In Woolworths' Sales, Aug. 27, 2020
  • Reece Has Flexibility To Manage Industry Downturn, Aug. 27, 2020
  • APA Group Has Sufficient Headroom To Manage Slowdown And Seek Growth, Aug. 26, 2020
  • Chorus' Results Signal Telco's Well-Wired Position, Aug. 26, 2020
  • Meridian Posts Strong Results Amid Tougher Conditions Ahead, Aug. 26, 2020
  • Spark New Zealand Might Face Difficult Dividend Decision, Aug. 26, 2020
  • All Eyes On Boral's Pending Portfolio Review, Aug. 25, 2020
  • COVID-19 Takes A Toll On Scentre Group's Buffer, Aug. 25, 2020
  • Fortescue's Bumper Earnings Boost Growth Plans, Aug. 24, 2020
  • Woodside's Higher Sangomar Stake Further Cuts Rating Buffer, Aug. 24, 2020
  • Consumer Staples Lift Logistics Company Brambles, Aug. 21, 2020
  • Santos' Asset Diversity Provides Protection Amid Weak LNG Markets, Aug. 21, 2020
  • Amcor PLC Remains Resilient In The Face Of COVID-19, Aug. 20, 2020
  • Coca-Cola Amatil Can Trade Through Temporary Earnings Fizzle, Aug. 20, 2020
  • South32's Financial Prudence Pivotal Amid Uncertain Outlook, Aug. 20, 2020
  • Wesfarmers' Bunnings And Officeworks Thrive Despite Target Challenges, Aug. 20, 2020
  • Casino Shutdown Starts To Erode Crown's Large Rating Buffer, Aug. 19, 2020
  • CSL Ltd. Resilient Amid Pandemic, Plasma Collection Challenges Ahead, Aug. 19, 2020
  • Dividend Cut Could Ease Singtel's COVID-19 Pain, Aug. 19, 2020
  • Coles Group's Grocery Sales Boom To Moderate Through Fiscal 2021, Aug. 18, 2020
  • BlueScope's Financial Discipline Supports Resilience During COVID-19, Aug. 17, 2020
  • High Gold Prices Boost Funding For Newcrest's Expansion Plans, Aug. 14, 2020
  • Goodman Group's Record Earnings Ride On E-Commerce Wave, Aug. 13, 2020
  • Telstra's Strategic Execution Paramount As Headwinds Gather, Aug. 13, 2020
  • Weak LNG Market Weighs On Woodside's Results And Growth Capacity, Aug. 13, 2020
  • Computershare Has Ample Buffer To Withstand Subdued Global Economic Outlook, Aug. 12, 2020
  • Coronado Global Resources' Liquidity Remains Tight, Aug. 11, 2020
  • GPT Group's Diversified Portfolio Weathers Pandemic Fallout, Aug. 11, 2020
  • Sydney Airport's Equity Raising Reduces Downgrade Risk, Aug. 11, 2020
  • Aurizon Can Manage Subdued Economic Conditions, Aug. 10, 2020
  • CIMIC Group's Selldown Of Thiess To Reduce Business Diversity, Supports Deleveraging, Aug. 5, 2020
  • Origin Energy's Capital Management Critical To Counter Rising Risks, July 15, 2020
Research updates/Commentaries
  • Tabcorp Holdings Outlook Revised To Stable Following Proposed Equity Raising; 'BBB-' Ratings Affirmed, Aug. 19, 2020
  • Brisbane Airport Has Solid Liquidity Buffer Amid Travel Slump; 'BBB' Rating Affirmed With Negative Outlook, Aug. 17, 2020
  • Asia-Pacific Corporate And Infrastructure Midyear Outlook 2020, July 30, 2020

This report does not constitute a rating action.

S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

Primary Credit Analysts:Richard Timbs, Sydney (61) 2-9255-9824;
richard.timbs@spglobal.com
Craig W Parker, Melbourne (61) 3-9631-2073;
craig.parker@spglobal.com
Graeme A Ferguson, Melbourne (61) 3-9631-2098;
graeme.ferguson@spglobal.com
Parvathy Iyer, Melbourne (61) 3-9631-2034;
parvathy.iyer@spglobal.com

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