Key Takeaways
- Elevated inflation and rising interest rates dominate the Australian corporate outlook.
- Consumer demand is starting to slow, while commodity producers are benefitting from elevated prices
- REIT valuations are eroding and capital is rotating from private to public markets.
- High-yield funding conditions remain difficult, but investment-grade demand is strengthening.
Inflation and rising interest rates are the top issue for Australian and New Zealand corporates. These risks are exacerbated by uncertainty over the level at which rates peak and their duration. Despite a strong December half, consumer demand is slowing and S&P Global Ratings expects a further waning during 2023. Cost inflation, while moderating, will remain elevated and pinch margins as demand slows.
Valuation Disconnect Causing Credit Headaches For Wholesale REITs
Ratings pressure is likely to persist in the interest rate-sensitive REIT sector. This is particularly acute in the wholesale segment, where sticky valuations are seeing a growing disconnect between unlisted and listed asset prices (see chart 1).
Investors have begun to cash out of wholesale funds at favorable prices, rotating capital into discounted public markets. This rotation will weigh on credit quality as wholesale funds seek to divest assets or use debt to fund redemptions.
Asset sales are likely to be struck below net tangible asset values, depressing asset prices across the Australasian real estate sector. Higher transaction volumes however should help to close the valuation gap between listed and unlisted markets. We expect that market participants will focus on rent security and cash flow generation to differentiate the stronger players in this dislocated market.
We recently downgraded APPF Retail and QIC Property Fund on redemption-related credit pressures, and expect others to face similar challenges in the coming months. While redemptions have centered on retail property funds, they will spill to the office space, in our view. A tougher macroeconomic outlook and structural challenges from hybrid working will start to weigh. We anticipate the August reporting season will show weakening asset valuations.
Chart 1
Hybrid Work Clouds Office Space Demand
Work from home remains a key structural risk for the office sector. Our rated REITs mostly hold premium and Grade-A office assets that can better attract and retain tenants as some downsize due to work-from-home arrangements. That said, vacancies will likely rise, and net rents fall, due to lower demand. The disconnect between between demand and supply is likely to be more pronounced in markets expecting significant new supply, such as Melbourne and Sydney, and will weigh harder if it coincides with deteriorating macroeconomic settings.
In our view, certain REIT operators will navigate these structural drags better than others. These include those with headroom within credit metrics. Other key factors are high-quality and well-positioned assets, long lease terms, favorable rent structures, and the ability to control development pipelines with adequately sourced capital.
Consumer Demand To Slow In 2023
While the Australian consumer remained resilient in the six months to Dec. 31, 2022, higher interest rates are starting to bite. Consumers are becoming more value-conscious and discerning in their spending. We expect these trends to intensify as cost inflation and interest rates press down on household budgets over the coming months.
Margins will likely narrow. Many consumer-facing companies have so far been able to pass through higher costs--this will become more challenging as retailers compete for reducing demand. We also expect the larger, better-capitalized consumer facing companies, such as Wesfarmers Ltd., Telstra Group Ltd., Coles Group Ltd., and Woolworths Group Ltd. to invest in price and grow market share in a weaker environment.
Commodity Prices To Remain Elevated, Particularly Energy
Conditions remain buoyant for commodity companies. Macroeconomic concerns, the China property slowdown and other factors have seen some commodities come off cyclical highs, but they remain well above long-term averages.
We anticipate energy-related commodities will stay elevated due to supply constraints from the Russia/Ukraine war and environmental-related supply factors. The reopening of China will support demand for iron ore, benefitting players such as Fortescue Metals Group Ltd. and BHP Group Ltd.
Given the past few strong years, sector companies can accommodate the higher cost of capital investment from elevated inflation. Significant growth in capital expenditure is underway at both Woodside Energy Ltd. and Santos Ltd. Recent strong cash flow on the back of higher prices and volumes has created substantial balance sheet flexibility to manage these projects within the parameters we expect for the ratings.
Downside risks include a more pronounced global slowdown than currently anticipated, which could shake commodity prices. Meanwhile, the Russia-Ukraine conflict continues to create uncertainty in price outlooks.
Chart 2
No More Easy Money For High-Yield Credit
The days of easy money for speculative-grade credit are over. Rising interest rates, widening credit spreads, and lower investor demand set a tough stage for 2023. Our recent downgrade of Genesis Care Pty Ltd. to 'CCC-' with a negative outlook reflects our expectation that the company will undertake a distressed exchange or some other form of default in the coming months. The company's capital structure is unsustainable, in our view.
Over the next 12 months, the availability and cost of debt financing will remain harsh for speculative-grade credits. That said, many of our rated issuers still have time to delever ahead of maturing debt over the next two to three years. Further, post-COVID tailwinds are supporting an improving revenue outlook for issuers such as Amplify MidCo Pte. Ltd. (Ticketek), which should support improvements in their capital structure.
Conversely, appetite for investment-grade debt is improving as rising yields boost their risk-return profiles. Many strong issuers have been accessing bank markets to provide flexibility during recent market volatility. But we expect several high-grade issuers to return to capital markets in the coming months as they seek to diversify their funding and extend their debt maturities.
Related Research
Rating actions
- Dexus Wholesale Property Fund Outlook Revised To Stable From Positive On Merger Completion; 'A' Ratings Affirmed, March 1, 2023
- Genesis Care Pty Ltd. Downgraded to 'CCC-' From 'CCC' On Heightened Default Risk; Outlook Negative, Feb. 8, 2023
- Australian Prime Property Fund Retail Downgraded To 'BBB+' On Persistent Unitholder Redemption Pressure; Outlook Stable, Dec. 21, 2022
- Voyage Digital (NZ) Ltd. 'B+' Rating Placed On CreditWatch Positive On Tower Assets Sale And Prospective Debt Reduction, Dec. 21, 2022
Bulletins
- High Prices Fuel Woodside's Funding Flexibility, Feb. 26, 2023
- Lottery Corp.'s Earnings Hot Streak Underscores Resilience, Feb. 22, 2023
- Fragile Consumer Demand May Sour Scentre's Retail Sweet Spot, Feb. 22, 2023
- High Prices Boost Santos' Funding Flexibility, Feb. 22, 2023
- Woolworths Reaps Benefits Of Stable Operating Conditions, Feb. 21, 2023
- Demand For Connectivity To Shield Telstra Amid Macro Headwinds, Feb. 16, 2023
- Fortescue's Strong Balance Sheet Supports Green Growth, Feb. 15, 2023
- Higher Rates Drive Bumper Computershare Earnings, Feb. 14, 2023
- Wesfarmers Well-Positioned For Consumer Cash Squeeze, Feb. 14, 2023
- CSL's Financial Deleveraging Remains On Track, Feb. 13, 2023
- Amcor Remains Resilient As Demand Tide Ebbs, Feb. 8, 2023
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: | Paul R Draffin, Melbourne + 61 3 9631 2122; paul.draffin@spglobal.com |
| Secondary Contacts: | Craig W Parker, Melbourne + 61 3 9631 2073; craig.parker@spglobal.com |
| Richard P Creed, Melbourne + 61 3 9631 2045; richard.creed@spglobal.com | |
| Aldrin Ang, CFA, Melbourne + 61 3 9631 2006; aldrin.ang@spglobal.com | |
| Richard Timbs, Sydney + 61 2 9255 9824; richard.timbs@spglobal.com |
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