The biggest winners from the Federal Election

Stuart Jackson

Montgomery Investment Management

The ASX All Ordinaries index jumped to an 11-year high immediately after the Coalition won the recent Federal Election. It was boosted in particular by share price spikes in the big banks and health insurers. Whether these gains are sustainable remains to be seen.

The results from the Federal Election not only surprised pollsters, political pundits and bookmakers, with equity markets also caught out. Having largely factored in the announced policies from an assumed Labor win, the market has reacted swiftly to revert back to a more ‘steady as she goes’ stance for domestic businesses.

The most significant impacts of the result were felt by the banks and healthcare related industries.

For the banks, the election result reduces the risk of a material step-up in punitive actions, an extension of the Royal Commission and aggressive rhetoric designed to score political points. This might have included an increase in the current bank levy. While the Coalition is unlikely to go easy on the banks, the potential threat was greater under a Labor Government.

One of the features of the recent bank results was weak mortgage demand, particularly from the investor segment of the market. The curbing of negative gearing provisions and halving of the capital gains tax rate concession under Labor would have been another negative for investment property demand. As a result, the election result is a relative positive for future mortgage book growth at the margin.

Following the election, APRA announced that it has begun consulting on a proposal to remove the minimum 7 per cent interest rate used by banks to assess the minimum servicing requirement of mortgages. This would further support mortgage book growth as it would increase the amount customers can borrow for a given level of income and expenses.

Both of these factors are likely to temper the near-term downside risk in residential property markets, reducing the risk of deterioration in credit quality and bad debts for the banks.

The potential removal of the 7 per cent minimum interest rate for serviceability would also provide more scope for a reduction in the RBA’s official overnight rate target to stimulate the economy, as the ability of consumers to raise additional debt would no longer be limited by the current serviceability requirements. However, the ability for the banks to pass on a reduction in the RBA’s official overnight rate to standard variable mortgage rates would remain constrained by the high proportion of their funding on which they already pay a zero or very low rate of interest (i.e. transaction and savings account deposit balances).

Given these benefits from the continuation of a Coalition Government, it’s not surprising that the ASX 200 Banks index climbed 10 per cent in the first 3 trading days after the election. However, the election result does not change the subdued outlook for earnings growth with constrained revenue growth given high household debt and pressure on fees, combined with the headwind of an inevitable increase in bad debt charges from current cyclical lows.

Among the healthcare related companies, there were clear winners and losers.

Private health insurance (PHI) providers will no longer have to worry about premium growth being capped at 2 per cent a year for the annual pricing changes on 1 April 2020 and 2021. Instead premium increases will remain a function of underlying claims cost growth and competitive pressures in the market.

Claims costs per policy have been growing at around 3.5 per cent a year recently. This is higher than inflation due to the shift in the mix of policyholders toward higher claiming older customers and growing demand for healthcare across the population.

The focus on improving the affordability of PHI will revert to industry reform that is designed to take cost out of the system. As such, premium growth is unlikely to return to the mid-single digit rates of a few years ago, but they are likely to stay at around 3 per cent in the medium term.

A 2 per cent cap on annual pricing growth assuming no change in cost growth would have reduced industry underwriting profit by around 40 per cent over two years given average industry underwriting margins of 5 per cent. The impact on the listed players in the market, Medibank and NIB Holdings, would have been less than the industry average given they operate at higher margins than the industry average, but it would have still been very material. The outlook for severe margin pressure in the medium term has now been removed, and the share prices of these stocks have reflected this change in the base case, with Medibank rising 10.8 per cent and NIB up 14.1 per cent in the first three trading session of the week.

The removal of the 2 per cent cap on PHI premium from the base case is also a positive for the private hospital operators, as it was expected that the PHI companies would be forced to push some of the pricing squeeze on to suppliers through lower price increases in future contracts. This has seen Ramsay Healthcare’s share price bounce a more modest 5.8 per cent. Interestingly, dental centre operator Pacific Smiles Group’s share price has actually fallen this week. Admittedly the stock has very low trading volume and the lack of reaction could merely be a reflection of the low liquidity in trading.

On the flipside, general practitioner, pathology and radiology groups were losers from the election result given the funding increases that were promised by the Labor Party. Healius is up marginally post-election on renewed press speculation regarding potential corporate activity, while Sonic Healthcare is roughly flat.

The potential for regulated increases in unskilled wage costs through a high minimum wage and the return of penalty rates presented a risk to industries that are large users of unskilled labour, such as retail and food service companies. This presented the threat of operating cost growth, which would probably have required offsetting efficiency measures and likely headcount reductions.

Labor’s more aggressive commitment to renewable energy would have impacted the future value of the existing coal power generation assets in Australia, as well as future coal mining activity and demand. These segments of the market are beneficiaries of the surprise result. The ongoing uncertainty regarding energy policy will make investment difficult and potentially risky for the generators given the long-dated nature of the payoff for such investments.

AGL and Origin Energy are both flat since the weekend, while coal miner Coronado is up 6.3 per cent and Whitehaven Coal up 1.4 per cent. Aurizon is also a beneficiary given the increased likelihood of the Galilee Basin being developed.

The market had also expected a Labor government would have increased the likelihood that the NBN would write down the book value of its asset. This would allow it to reduce wholesale access charges and still meet its asset return target. This could have allowed resellers of NBN services like Telstra and TPG to improve margins as long as competitive conditions did not force them to pass on all of the reduction in wholesale prices to retail customers. With an asset write down now less likely, the probability of the reduction in wholesale NBN prices has also reduced. The major telco stocks are essentially flat since the election.

The other impact is on demand for income paying stocks. We had arguably seen a rotation away from high fully franked dividend paying stocks like the banks and Telstra, in favour trusts that pay distributions from pre-tax income (e.g property trusts, toll road operators and airports), ahead of the election as a result of Labor’s policy in removing franking credit refunds. This is likely to reverse post-election.

It is also likely to see plans for off market buy backs by companies with large franking credit balances put on hold.

One of the more difficult things to estimate is the impact on business and consumer confidence. While businesses can generally be expected to favour a Coalition government, business also wants stability and certainty. The Coalition looks like it’s returned with an increased majority, but its majority remains slim at 2 or 3 seats in the House of Representatives. It will also remain reliant on the support of the cross benches to pass legislation in the Senate. The election probably has not delivered the definitive mandate business had been hoping for (to either party), which will temper any impact on business confidence.

Stuart Jackson
Senior Analyst and Portfolio Manager
Montgomery Investment Management

Stuart is the Portfolio Manager of The Montgomery [Private] Fund – a concentrated, All-cap Australian equity fund that aims to achieve absolute returns from a portfolio of long only Australian shares and cash. Capital preservation is paramount.

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