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Vaccines Won't Be A Cure-All For Australia And New Zealand Corporates And Infrastructure

(Editor's Note: In the version of this article published earlier today, we misstated the ratings on Orica Ltd. and Chorus Ltd. A corrected version follows.)

With vaccine rollouts underway and economies strengthening, many Australian and New Zealand corporates are turning their attention to the opportunities available beyond the pandemic. S&P Global Ratings believes that ongoing government support, low interest rates, and rising commodity prices provide a supportive backdrop for improving credit metrics and repairing balance sheets.

However, scars from COVID containment, together with ongoing structural concerns, will continue to weigh. This is especially the case for corporates and infrastructure companies that suffered the brunt of the lockdowns. Further challenges will come from trade disputes and global supply-chain disruptions from COVID.

Environmental, social and governance (ESG) risks are becoming increasingly relevant for some issuers. This can knock on to the availability and cost of capital, particularly for those exposed to carbon intensive industries or facing governance concerns.

Improving Economies, Higher Commodities Are Credit Positive

A broader-based rebound in commodity prices improves the earnings outlook for many commodity sectors following a challenging first half for the 2021 financial year (ending June 30, 2021). Coal miner Coronado Global Resources Inc.'s (B/Negative/--) earnings suffered heavily on the back of lower coal prices and China trade disruptions, at a time when the company faces mounting ESG concerns and weaker access to capital. Spillover effects of lower commodity prices and trade tensions are also hitting adjacent industries, such as explosives provider Orica Ltd. (BBB/Negative/A-2)

However, we expect continued strong iron ore and gold prices to bolster the earnings of Fortescue Metals Group Ltd. (BB+/Stable/--) and Newcrest Mining Ltd. (BBB/Stable/--), allowing higher dividends and expansion plans to be funded within ratings tolerances. Mining service providers such as Mineral Resources Ltd. (B+/Stable/--) and EMECO Holdings Ltd. (B+/Stable/--) are also benefitting from a firmer demand outlook.

In the oil and gas space, long-term industry risk from the energy transition to renewables has led us to reduce the ratings headroom on Woodside Petroleum Ltd. (BBB+/Negative/--) and Santos Ltd. (BBB-/Stable/A-3) as the companies plan major capital investment programs. Nonetheless, rising gas prices are providing earnings support ahead of key financial investment decisions.

At-Home Consumption Is Coming Off COVID Highs

At-home consumption growth continued to bolster the earnings of retailers such as Wesfarmers Ltd. (A-/Stable/A-2) Woolworths Group Ltd. (BBB/Stable/A-2), and Coles Group Ltd. (BBB+/Stable/--)during the half, as well as those leveraged to these broader trends, such as packaging company Amcor Pty Ltd. (BBB/Stable/A-2), and Australian Postal Corp. (A+/Negative/A-1) Greater time spent at home also supported lottery demand and a solid earnings recovery for Tabcorp Holdings Ltd. (BBB-/Stable/--)

Although we expect the performance of these companies to remain robust, the peak of pandemic-induced demand may have passed as consumers reemerge from lockdown and consumption patterns shift to other activities.

Work-from-home arrangements also helped the likes of Chorus Ltd. (BBB/Stable/--) via increased demand for fixed-line services. Telstra Corp. Ltd. (A-/Stable/A-2) is approaching an earnings inflection point as its mobile earnings offset the loss of its fixed-line services to the National Broadband Network.

We also anticipate the nascent recovery in residential building activity will support the likes of BlueScope Steel Ltd. (BBB-/Stable/--), Reece Ltd. (BB+/Stable/--), CSR Ltd. (BBB+/Stable/--) and Boral Ltd. (BBB/Negative/--).

Structural Challenges Cloud The Recovery In Retail Real Estate

Industrial real estate players such as Goodman Group (BBB+/Stable/--) continued to outperform, again spurred by high e-commerce demand and a booming logistics chain.

Although shopping-center owners, including Scentre Group Ltd. (A/Negative/A-1) and Vicinity Centres (A/Stable/--), enjoyed improved rental collections during the half and maintained fixed rental arrangements, a downward rebasing of rents is likely and will continue to weigh on earnings. Structural concerns also remain a persisting threat as online shopping penetration continues.

Office property markets face the structural overhang of an enduring shift to work-from-home arrangements. This trend will likely reduce aggregate office demand and weigh most heavily on secondary grade assets and builders with uncommitted development projects.

ESG Factors Are Increasingly Influencing Capital Flows

In our view, the focus on ESG factors is intensifying and is hitting capital flows and putting companies' license to operate (social and legal) at risk.

For carbon-intensive players, such as coal miner Coronado, ESG considerations are playing a growing role in capital cost and availability, which is likely to continue to weigh on credit quality. We expect the reallocation of capital away from fossil fuels to challenge the credit quality of operators that fail to reduce their carbon emissions.

Crown Resorts Ltd. (BBB/Watch Neg/A-2) remains under threat of license revocation from significant governance failings as it strives to convince various regulators that it remains a suitable casino license holder.

Low Interest Rates To Drive M&A And Investment

Buoyant capital flows and low interest rates are providing fertile ground for mergers and acquisition (M&A) activity. Although rising long-term rates threaten this supportive environment, we expect M&A activity to accelerate in 2021. Woolworths Group's separation of the Endeavour Group liquor business is planned for mid-2021, Boral's divestments program continues to progress, and further M&A activity is possible in the real estate and oil and gas sectors.

Low interest rates continue to provide a favorable climate for infrastructure companies to fund capital expenditure at an attractive cost. Increased infrastructure investment should also create much-needed growth opportunities for engineering and construction company CIMIC Group Ltd. (BBB/Watch Neg/A-2) after the COVID-related slowdown in activity and problem projects hampered 2020 earnings and cashflows.

A Long-Haul Journey For Infrastructure

COVID's uneven impact on infrastructure will begin to iron out as the recovery progresses. We expect a slow climb-out from the extreme hit to airports, which experienced an almost complete drop in international traffic. Domestic traffic has begun to slowly pick up with passenger levels more recently averaging around 20%-40% of pre-COVID levels across Australian airports, and 50%-65% in New Zealand. In our view, widespread global distribution of the COVID vaccine will be required for a concerted recovery.

At the other end of the spectrum, vehicular traffic has recovered strongly with traffic on Transurban Finance Co. Pty Ltd.'s (BBB+/Negative/--) toll roads in Sydney and Brisbane back to more than 90% of pre-COVID levels. Melbourne traffic has been slower to improve due to multiple lockdowns. The earnings of Aurizon Holdings Ltd.–-and its two rated subsidiaries Aurizon Operations Ltd. (BBB+/Stable/--) and Aurizon Network Pty Ltd. (BBB+/Stable/--)--were hampered by slower coal demand and access issues into China.

On the energy side, lower wholesale prices and softer energy demand weighed on the earnings of Origin Energy Ltd. (BBB/Stable/A-2). In New Zealand the decision by Rio Tinto Ltd. (A/Stable/A-1) to extend operations at its aluminum smelter until at least December 2024 provides positive support for market demand and the operations of Meridian Energy Ltd. (BBB+/Stable/A-2) and Contact Energy Ltd. (BBB/Stable/A-2).

A Note On Our Coronavirus-Related Coverage

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

Research Updates:
Commentaries:
Bulletins:

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 Analyst:Richard Timbs, Sydney + 61 2 9255 9824;
richard.timbs@spglobal.com
Secondary Contact:Paul R Draffin, Melbourne + 61 3 9631 2122;
paul.draffin@spglobal.com

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