Under pressure: the rising cost of living

Viral Patel:

Welcome everybody to this webinar by Fidelity on under pressure and the rising cost of living. I'm just going to give it a minute more as we've got all lots of clients joining at this point. All right. That seems to have stabilised. Just in terms of the agenda for this call, I'm going to do a very quick introduction. I'll give you a few observations for me on a top-down and insights that we are gaining from across the platform. Then, I'm going to straight away jump into Q and a with the panel. We have Justin tier here who's the energy analyst, Monique who's the rates analyst and Brendan who's the industrials and consumer analyst. Please send through any questions you may have on the Zoom portal. Just for me on observations, very top down level, right?

The main question is I guess right now soft and hard. Relatively, in some way Australia is much better placed. We have China, who's had a zero COVID policy, which is now starting to open up. US has high inflation, rates are rising, et cetera, high valuations. Europe has high inflation, high energy cost, security, supply, geopolitical issues. Australia is well placed. Commodity hedge, exposure to DM markets, lack of tech and high PE stocks. But we need to be very selective in the equities and sectors we invest in also in Australia going forward especially. In Australia, we have a very high nominal GDP growth at this point, strong real growth, as well as high inflation. We haven't yet in our view seen the peak of inflation at this point. Wage price inflation is yet to come through. All of the other things still stay. We'll talk more in terms of where the inflation is coming from in this call.

And then sort of long term also outlook for us, there are still inflationary pressures from greenflation, deglobalization, massive increases in money supply, et cetera. Australia specifically, we'll talk more about house pricing, et cetera. But the main impact we see from rates rising in Australia, which we expect to see going forward including at 2:30 PM today. But the main impact we see over the next few months year is really impact on consumer spending and on the economy. So with that just as a top down view, I'm just going to start the Q and A. We've got a number of questions already in, so I'll start with our energy analyst, Justin. Justin, in your view, energy trades, do you think it's at peak levels? And also thoughts on currency given commodity prices, et cetera right now?

Justin Teo:

Thanks, Viral. I think from an energy perspective, there's still a bit more to go. And I'll start with sort of supply and demand dynamics. I was travelling in Texas in May where the US Shell has been a huge increase of supply over the last 10 years. But what's become very clear is that there are some really real supply chain bottlenecks that are impacting US Shell producers' ability to expand production. First of all, there's labour, which is very well known. The anecdote we were getting was that lots of Amazon truck drivers prefer that to driving sand around in the Permian Basin in Texas, because I think they get newer trucks, nicer quality of living, and less long haul looking at the desert driving.

But also from an equipment point of view, a lot of the steel prices have actually risen and that is driving higher oil and gas equipment prices, but also freight is taking a long time to get things to shore because a lot of these products are actually manufactured outside of the US. So the willingness of oil and gas producers might be there to increase production, but their ability to actually do so in a very fast way is being reduced I think versus the last time we had an oil cycle. And then on demand, I think I was quite worried about whether China would continue its lockdowns. But we clearly see an easing in restrictions for mobility in Shanghai and more recently in Beijing. So while we don't have a definitive relinquishment of zero COVID policy from a China point of view, that definitely is a demand buffer that might not have been there if they continued in lockdown. So ultimately we still see the market slightly short oil from a supply perspective and demand is still rebounding. Perhaps not quite at pre COVID levels, but quite close.

In terms of the currency thoughts, I think it's quite clear the Fed has a larger inflation problem to deal with in the US than in Australia. Roughly speaking, US was looking at close to double digit inflation and Australia was maybe half that. So I think we will see it right rapid rise in rates in the US, which will drive probably a strong I guess US dollar versus other currencies. But where Australia has some support, as Viral mentioned, is this very commodity based economy. And if commodity prices stay high, including oil, gas, energy, iron ore, you probably will see more resilient currency in that 70 sort of range. So I think it's close to fair value from a currency perspective and we sort of weigh up what happens with the commodity complex. I'll pass it back to Viral.

Viral Patel:

Great. Thanks, Justin. Just moving over to the topic that's always interesting in Australia is housing, right? And with rates having gone down over the years, of course we've seen a good positive impact, rates looking like they're rising plus inflation, et cetera. Monique your views on real assets, property, et cetera, and impact on Australian economy?

Monique Rooney:

Yeah, sure. Look, yeah, as you said, Viral, property, we've seen record pricing be it in the housing market and also commercial property with record low interest rates. But now we're moving into a rising interest rate world. You would have to expect that that heat and some of that strength that we've seen in recent years will unwind. On the commercial property side of things just to cover that off, valuers typically take a wait and see approach, and they'll wait to see where bond yields settle. I think at June update, we'll likely see assets probably stable to even slightly up. But I think it is becoming more consensus. And from my discussions with valuers that from December, we will start to see commercial property values come down. Obviously, the other side of the equation is rental growth.

So you want to kind of have pricing power, CPI linked, strong supply demand fundamentals. So where there's stronger rental growth, there'll be probably more of a buffer. So that's probably more an infill industrial and retail. But where there is weaker fundamentals and also lower rental growth, then obviously that'll be more impacted from a change, and that's probably office at the moment. In terms of the housing market, look, obviously it'll be dependent on how high and how quickly interest rates go. As you said, we've only had one rate hike and we're likely to get another this afternoon. But the housing market for now is still holding in there. We did see, year on year things are still up substantially. But we did see our first month to month decline and national house prices in May and auction clearance rates, which are lead indicator of future housing prices, they have fallen since April. And we're sitting now in the fifties for both Sydney and Melbourne.

When I speak to Stockland, they saw a bit of a moderation in inquiry level post the first rate hike, but things have actually been holding up pretty well. Mirvac, pricing's still holding, but they are seeing sales momentum slow in their apartments, which they're giving it a push. But both companies will be very open in saying that the pain is yet to come over the next six months. And so again, that'll be based on where interest rates basically go, how high, how quickly. But I think you just have to look at markets like New Zealand and Canada that are probably further ahead than we are on this interest rate hike cycle to see that values have fallen for the peak. And so likely over the next six months plus, I would expect that housing will come under pressure and volumes as well and we'll see that fall some more.

Viral Patel:

I think, Monique, we just slightly lost you at the end there. I'll come back to you in a second. I'll just move on to Brendan. Brendan, so we'll hear from Monique again in a minute on her views on interest rate hikes, et cetera. What's the impact on your sectors around food, food, inflation, travel, airlines, et cetera?

Brendan Mowry:

Yeah, sure. I think if you're thinking about food inflation, you rewind back to mid last year, third quarter. We started seeing research and meeting notes, come back from our colleagues in North America and Europe suggesting that the global consumer good suppliers, so Unilevers, Kraft, Heinz, Nestle had started pushing through price rises in the mid single digits. At that point, you knew that those pressures were going to cascade down the value chain to the supermarkets and then ultimately the consumer. I think today, fast forward, we're seeing food inflation coming through now in the mid single digits. I think it's reasonable to sort of expect that to continue to accelerate throughout this quarter. Supermarkets are obviously the beneficiary of that. Demand's inelastic, you have the capacity to pass through those past price rises to consumers.

Then, I think if you're talking specifically about housing on a direct basis, 40% of Metcash earnings comes from its hardware businesses. So they're more trade aligned, which over the short term will be supported by the backlog in work orders and east coast floods remediation. But there's going to be inevitably an impact there. Then I think indirectly, and this extends beyond housing and into the consumer pressure more broadly, you're going to start to see consumers trade down. You're starting to see that over in the US with the recent updates from Walmart and Target. It was a similar experience in the GFC. But again, for the supermarkets, the frozen food items, private label, who would be that beneficiary of the trade down, they're typically a higher margin product. So again, supermarkets are relatively well placed in that environment.

Viral Patel:

Cool. Just back to you, Monique. Just your views on interest rate hikes. How far do we think we go? What's the market pricing and what's the impact on spending?

Monique Rooney:

Sure. Yeah. Look, I think the focus for central banks in Australia and both globally is about getting inflation under control. And so the mechanism to do that is by raising rates. I think that they'll probably go hard. They'll then probably pause, take stock and see where the economy's at before kind of proceeding. But I guess the other thing that we have to consider is how wage inflation interplays with interest rates, because potentially if we have strong wage inflation growth, then that could lead to upward pressure on interest rates. In terms of where the interest rates go, that is the million dollar question. I don't have a crystal ball. But certainly what I can tell you is what the forward curve suggests and currently that is pricing a 2.9% interest rate. I mean, that would imply people servicing mortgages at 5.5-6%, which is materially above where people are servicing their mortgages today.

I think certainly household debt has increased in recent years so there is much more sensitivity to changes in interest rates. A hundred basis point hike in interest rates on a 750,000 loan would hit the average household by 8%. So obviously if the RBA does what the market is pricing and suggesting, then this is going to have a material impact on consumer balance sheets. I think they'll struggle to stay above water. So that's what the forward curve suggests. But then it's worth mentioning that Matt Common, he thinks that the RBA will loosen their fight with inflation over the course of the year and that interest rates will settle at sub 2% at the end of calendar year '23. So from here, it's hard to see where it goes. There'll be a range of factors though that will ultimately influence that over the next year. I think one thing for sure is that rates are going up and that consumer balance sheets will come under pressure as a result.

Viral Patel:

Thanks, Monique. I'm just going to add there, we just had a team call and on that call the financials analyst mentioned that fixed rate as a percentage of total stock has gone on dramatically in the last two years. Is where in the past Australia was and still is mostly variable, which sees an immediate impact of rate hikes on mortgages, in the last two years given low rates, a lot of people have increased their exposure to fixed rates. So currently something like a third of total mortgages are fixed rate, and that's still got another year, two years, a year to two and a half years to see those people getting impacted. But again, when they do, it'll be quite a dramatic move from where they are to a higher level. So that's just on the housing impact on mortgage, which as Monique said, will impact spending home spending budget by 8%. Then just moving back to energy, Justin, we read all about gas prices through the roof, coal power plant shortages because of issues and electricity price is up strongly. What's your views on the inflationary pressures on there? How long does it last?

Justin Teo:

Sure. I separate it probably into I guess household electricity and gas prices. And then you sort of have the I guess liquid fuels and driving your car, gasoline, petrol. Just on the latter first, there hasn't really been an impact I think from the higher $2 litre petrol that we see in terms of driving. Maybe that's a bit of the people want to get out of the home or out of the lockdown zone and then there's a bit of an uptick there. But that's consistent in the US as well where the precursor to decreasing use of those fuels, demand destruction, is downgrading from premium. So it might be downgrading from 98 to 95, 95 to E10. And that hasn't really happened yet in the US or Australia. What you're seeing is that demand is pretty in elastic partly I think because a lot of cars require some of these higher opportunity fuels as a minimum thing to keep your engine healthy. And that's partly a fuel efficiency standard through.

What happened I guess in terms of maybe thinking about residential, you've seen a few retailers go bankrupt in Australia. I think they're quite small ones. They're not the Origins or AGLs of the world. One called Western Energy recently happened. And this is what happened in the UK about six months ago, where they're probably six, nine months ahead of us in terms of what happened, where there was a 50% of rise in electricity, gas prices. In the UK, they're going to have another 50% rise in October, because it's a six monthly reset. In Australia, come July one we'll probably get a similar magnitude.

What that probably means is that people have to cut somewhere else I think. It might be more in consumer discretionary barriers because ultimately it's very hard to prorate down your electricity consumption or your gas consumption because if you're cooking at home, that's something that it might be more expensive to go out and eat a restaurant, right? And these are things that are probably fixed costs in people's budgets. And so at the same time that rates are rising into that, it's a double whammy that you get, I think from a duration point of view the key season is winter and now where we're seeing price limits put in that commercial gas of $40 a gigajoule. That's a regulated price cap that could probably sustain for a few more months and then it'll abate after winter peak demand.

And partly it's pretty cold at the moment and I think the weather has an impact on this while we also have coal generators out of commission. And these are sort of older plants and they seem to go out of commission more often versus five years ago. I think that's something that doesn't change. We're really waiting for warmer weather and I guess in some ways international markets to maybe change a little bit and we can get less pressure. But I don't see broad government intervention yet because I think the government's still getting in place what they want to do.

Viral Patel:

Thanks, Justin. And just fuel price impact, Brendan. Qantas Airlines.

Brendan Mowry:

Yeah, definitely. If you sort of rewind to pre pandemic times. Fuel was sitting at 60 odd dollars and now it's well over a hundred. If you're looking at purely just Qantas's capacity to offset that impact, it's going to effectively require them to raise prices by about 7-8%. And if you look over in America interestingly, capacity over there is back to about 90% of pre pandemic whereas revenue is now, on domestic travel at least it's tracking ahead of pre pandemic. So they've been successful in pushing through those price rises and they haven't seen the impact from the consumer in terms of pushing back against that. And Qantas's latest update, they actually revised their domestic capacity expectations down and you'd expect to see a fairly similar trend take place in Australia as well.

Viral Patel:

Brendan, what's the demand levels of travel in Australia and what's the capacity of the airlines as it come back to pre pandemic levels?

Brendan Mowry:

Yeah. So it differs if you're looking at international versus domestic. International outbound has been the laggard. So that's sitting at about 50% capacity. But you're actually getting extremely high utilisation. So there's a lot of evidence there that there's pent up demand. So you're getting 95% plus utilisation as in bumps in seats, whereas domestically we're actually above pre pandemic capacity and similarly, very high utilisation. So travel in general has been one of the bright spots in the consumer discretionary space over the last few months. And we're seeing finally after a little bit of clarity and clear air, we are seeing that release in pent up demand that a lot of people who have looked at the sector over the last few years have been waiting for.

Viral Patel:

And just for you Brendan again, just looking forward, domestically people are moving around. We're getting some international travellers in. China has still got a zero COVID policy where the international borders are still closed. What would the impact of that be if we didn't have Chinese tourist, Chinese students coming down here in the next six, 12 months or who knows how long?

Brendan Mowry:

Yeah. It's a difficult one because obviously that has a carry on effect on bringing back international outbound capacity and returning that to sort of normal because you need travellers to be going both ways to bring that back to pre pandemic capacity. So it is definitely a headwind moving forward. But what we are seeing is just... It was interesting. I had a conversation with Flight Centre recently and they said that another investor had asked them, "Is the federal government election going to have an impact on demand?" And their response was effectively, "If you're asking that question, you're not grasping the title wave of demand that is coming." And so we are seeing just this release of pent up demand paper over the cracks where there might be headwinds. And obviously the inbound, outbound equation with China is one of those headwinds. But yeah, certainly within the consumer discretionary space, the airlines hotels and travel companies have been one of the bright spots. You're seeing definitely a shift in the consumer's wallet away from goods and apparel towards experiences and services.

Viral Patel:

One of the reasons why Australian inflation is below US levels right now, we are at about five, they're at about eight is really wage price inflation. So they have seen massive wage price inflation. We haven't. Now we hear anecdotal evidence from companies in the RBA that companies out here have been holding off on wage price increase to not have fixed cost increase, et cetera. But now we have a government change. We have various things coming through and also we don't know what the immigration policies et cetera are going to be. Just based on your sectors starting with you, Justin, what are you hearing seeing anecdotally about labour and shortages, et cetera?

Justin Teo:

Sure. I think the mining sector was probably early in terms of this because there was a lot of fly in, fly out workers into Western Australia that were constrained during COVID. That includes flying from Queensland to WA, you east coast, west coast and also international in. You haven't really seen people return in into that industry. And part of it was there's quite strong demand for labour in the east coast as well, let alone international. That's definitely been an impact where you're seeing companies compete with each other for the same workers and all that results in is wage price inflation from an employee level. What you're sort of seeing more acutely though I've noticed in a few of the other industrial companies is that they're all competing for tech talent. That's an interesting aspect because you're not just seeing technology companies per se competing for this, but you're seeing regular industrial companies, financial companies all competing for that pool.

I think that pool's particularly acute in Australia because you relied on a migrant workforce I think that was migrating from countries including India, including other sort of UK Ireland, et cetera. And that pipeline is small. But from a pure energy perspective, what you're seeing as well is people wanting to work more in I think the new energy areas or the clean energy area and less people wanting to work in the fossil fuel area. And that's been a constraint that is probably more structural and that comes from university level. I think one anecdote is some people are calling the new mining engineering degree just mechatronic engineering to make it more attractive than the mining industry. And petroleum engineering is going to be called energy and Woodside Petroleum renamed themselves to Woodside Energy. That's partly an internal employee proposition, not just some greenwashing or anything like that. It's that people want to work for industries with positive change characteristics. And so that's not really a dollar thing. I think that's more a purpose thing and that's at the employee level.

Viral Patel:

Cool. Brendan, for you on hotels and restaurants, et cetera?

Brendan Mowry:

Yeah, definitely. Similar to what Justin was saying I guess. A lot of those industries do rely on the migrant workforce. So when you speak to the likes of Flight Centre and Hello World and these travel operators, the biggest obstacle to them is capacity coming back online, but also having the staff to cater to that demand. I think that extends not just within that travel and leisure space, but right through the ecosystem speaking to Endeavour, which is your BWS, Dan Murphy's and one of the largest hotel operators. They can't find cooks and things like that. So yeah, it's definitely a headwind. And when you're thinking about just wage inflation more generally, discussions with the Woolworths chair not too long ago that they want to take the lead on pushing through wage... wage rises rather. And so when you've got one of the largest employers in Australia taking that stance, I think it's fair to expect that we are going to see wage rises towards the back end of the year.

Viral Patel:

Yeah. I guess given around 50% of Australian employees are either on minimum wage or EBAs, any change coming through from the labour government on either of those will see quite immediate impacts coming through on wages and hence inflation and continued impact on rates. And Monique, just for you on your property sector, also what read throughs from your landlords are you getting on all their supermarkets, et cetera?

Monique Rooney:

Sure. Yeah. Look, firstly, on the labour side of thing, certainly on the corporate level, they have been talking about inflation come through. There is real competition for talent. One of the companies that I cover actually talked about having to put through a 10% increase in wages across the company just in order to help retain them. Specifically it certainly is an issue given the market is so tight. But I guess as well where the property companies are also seeing it is on the construction side of things. We all know very well the issues that we've had from material costs going up, but the labour shortage is also a real issue in the construction industry at the moment. So we've, we've had weather events as well and high materials, but the labour shortage is also leading to a bottleneck in basically companies' ability to get work done.

So we have seen the Mirvac and Stocklands have to come back and update the market and downgrade settlements because purely they just, they can't get through the work that they've got at the moment because of labour shortage issues, as well as the others. In terms of read through in terms of what the property guys are seeing for the supermarkets, look, for neighbourhood malls it's about turnover rent. So they certainly talk about inflation being a positive for the supermarket sales and supermarkets have had a strong run the last couple of years given lockdowns in COVID. But I think suddenly the feedback is that they're seeing sales continue to hold, to slightly grow as we see this inflation come through. I guess in terms of visitation, we did see the destruction of Omicron. Just return and visitation is starting to creep up as we cycle through all of that. But certainly spend per customer is up as people have more purposeful visits at this point in time.

Viral Patel:

Cool. Thank you. Justin, back to you again. Client question coming through. Will the Russian sanctions cause permanent damage to the economy?

Justin Teo:

There's probably two aspects to that. So I think one is financial. It's very clear now that the Western financial US dollar system is not going to work for the Russian economy. How does that impact them? It just makes things have a lot more friction, right? Because every time you're trying to deal with someone they basically need an intermediary to deal with you. And Russia's very publicly asked for rubles right payment in gas rather than the traditional method of just paying in a normal bank account. And some European countries have caved in to that because they need the gas. But I think for other goods and services where there are alternative substitutes, you will see a deterioration I guess in the Russian export market for their goods.

There's two notable exceptions to that, which is China and India, both clearly still importing Russian oil very publicly. That's sort of in the public domain, in the press. But where you're seeing those sideways moves by the EU and the US is things like the insurance market, which a lot of it's run out of Lloyd's in London and it's basically making it very hard to ensure anything that touches the Russian supply chain. I think these are more structural drivers that over time will make them try to be more self-sufficient in many ways. But on the other hand looking at the resource sector, which is very large in Russia, you can't really move the resources. So as long as there are some consumers looking to purchase these natural resources and there's an end market for it, they'll continue. And there is internal Russian technology. I'm less looking at, "Does Western technology really increase Russian oil production?" or something like that. I think they've been producing for a very long time themselves. I think there isn't that external reliance for those areas. But the financial sanctions over time I think will have strong repercussions.

Viral Patel:

Cool. Thanks, Justin. Monique, just over to you again with this Russia, Ukraine impact, supply chains, et cetera. Any readthrough from your industrial stocks on inventory levels and also on the tech companies continuing to invest given the route on the share prices?

Monique Rooney:

In terms of, yeah, okay, industrial. Yeah. Look, China as well obviously locking down has credit issues. So you have certainly seen a lot of stockpiling ahead in recent because they do not want to be caught out in the last couple of years. Sales as well for certain I guess retailers have been impacted as they haven't been able to meet demand. So definitely in terms of inventory levels, you just have to look at vacancy in the industrial sector as sub 1% in key markets. There are strong demand. And a big part of that is also pharmaceuticals having to stock palm oil. They're in a more of a just in case as opposed to a just in time type of model.

I guess as well, looking at some of the retailers and Brendan can tell you that too, that you have seen them go ahead of key selling periods and increasing inventory, which also has its risk on the other side of things. If we obviously have an environment that deteriorates, then that can obviously lead to greater discounting. But in general, yeah, inventory levels are much higher since the pandemic given the environment that we currently live in today.

Viral Patel:

Cool. That sounds good. Thank you, Monique. Moving to Brendan, Brendan, just any thoughts on supply chain impacts and shipping costs, et cetera?

Brendan Mowry:

Yeah. I guess throughout the pandemic, we've actually seen about a three to four X increase in the cost of shipping a container around the world if you look at the various indexes. But that has been sustained now at elevated levels for a decent period. It's come off a little bit over the last three to four months as we've started to see some cracks appearing in the consumer over in the States and rejection rates picking up a little bit. But I think, yeah, just echoing the sentiment that Monique provided there where a lot of retailers were forced to order ahead of time to get around some of these supply chain issues that all of the retailers were facing at the time and extended delivery times and whatnot. And there have been cases now in the states where you've seen retailers then sitting on excess inventory that was ordered ahead of time, based on an outlook of a consumer that has since deteriorated. And that obviously risks clearance activity, discounting and margin compression. So I think that that's a risk forward.

Monique Rooney:

Viral, it's probably worth adding as well just in terms of supply chain and the impacts on construction given how topical that is at the moment, in terms of I guess material costs have gone up substantially. I think on the listed side of things, the Lendlease and the Mirvacs of the world have been able to procure at scale and locking costs ahead of time. So they've seen single digit inflation. But certainly their third parties have seen cost up 20-30%. I'm sure if you speak to a neighbour doing renovations, you'll hear that anecdotal feedback too. But in terms of I guess speaking to the developers, sure, you have seen lumber prices come up from highs. But copper is still elevated. So speaking to developers, the view is that they're not expecting any meaningful reduction on the cost side of things over the next 12 months. They are expecting it'll be another 12 to 24 months before we start to see any kind of normalisation on construction cost at this stage.

Viral Patel:

Yeah. And also anecdotally from what I'm seeing in the building I live in terms of construction work projects, six months ago that was going to be priced. Now it's up 50%. So the interest rate of fixed price contract at this point is really, really low. They're planning for a lot of redundancies in there. So just for all three of you one after the other and I'll start with you, Monique. So margin impacts on companies and sectors and industries going forward is going to be important to how they perform share price wise, of course also where the valuation's set.

But the three things we've talked about today, wage prices are likely to go up. We don't yet have a clear view of what the immigration policies of the government are, but the wage prices will go up. Energy is already up and we can see it say at these elevated levels for a while. And interest rates are going up so companies that are more highly geared, et cetera, are going to also have an impact and the ability whether they can pass through or not. So just your thoughts from each of you just very quickly. What sectors or companies do you think are better to invest in that can withstand to these current issues?

Monique Rooney:

Sure. Just on I guess the property side of things, rental growth being top line, I guess where you want exposure is where, yeah, I said strong supply, demand fundamentals, where they have pricing power and typically CPI linked as well as is very favourable. So the retail malls, so the Westfields, kind of over 70% of their income is actually CPI plus 2%. So that provides a nice inflation hedge I guess for the retail mall. You also have other... the Charter Hall Long WHALE, they have over 50% of their leases is also linked to CPI.

And then industrial infill. Not all industrial's the same, but certainly infill where vacancy is very low and you're seeing substantial increases in rental growth. So that will help offset. I guess lucky for them labour is I guess a smaller percentage relative to other companies. So as long as they can get that top line growth, that's really important. The other thing as well that people have really focused on in the rate coverage is as well the low levels of hedging given where interest rates are. So the expectation is from low level hedging that interest rates will go up substantially and the interest line will go up. So yeah, look, again at the moment, the better pockets is probably the retail and also infill industrial at this stage.

Viral Patel:

Cool. Thank you. Brendan?

Brendan Mowry:

Yeah. I guess very simplistically, the way I frame it is sort of with all these pressures evolving, the consumer's wallet is shrinking a little bit. And within that, you've got your non-discretionary and your discretionary spend. And obviously your non-discretionary spend, your supermarkets, your food, demand's inelastic. And so as a proportion of the overall consumer's wallet, that's going to grow. And I think that it's a reasonable defensive exposure and historically beneficiaries of inflation because they can pass on those costs to consumers without much pushback. And then on the discretionary side, we are seeing the pendulum swing between apparel and goods back towards experiences and services. I see your travel and leisure stocks as being relatively better positioned to face these pressures as opposed to some of your apparel and goods retailers. I think that's probably the easiest way to look at it within my space.

Viral Patel:

Cool. Thank you. Justin?

Justin Teo:

Within the NG complex, I'd split it into three areas. You've got Ampol and Vivo, which are basically petrol stations with relatively inelastic demand profiles and recovering from earnings from a COVID lockdown perspective year on year. Then you've sort of got the LNG export, domestic gas players Santos and Woodside, and they're internationally traded prices. And now you could sell into the domestic market for pretty much more than international price parity. But then where this comes down in the energy space, less positive on is probably the electricity space. And because it hits the residential customer directly, you probably have a high risk of sort of policy intervention. You have a long string of months where you have record high electricity or gas prices and the ability to pass it through is generally very limited because you'll end up with governments taking away over earning I guess over that period.

Viral Patel:

Cool. One question on sustainability. I talked about green inflation earlier and the likelihood of needing to invest in sustainability means more demand for products, materials, construction, et cetera. But just start with your three sectors again, where and how much the speed of sustainability investing, just especially in the energy space in Australia, just your thoughts on that.

Justin Teo:

Sure. I think the narrative changed a lot in sustainability from, "Let's divest all fossil fuels," to it's actually like a transition and that transition requires investment across the value chain because one of the constraints has been that consumer demand for fossil fuels is still growing even. So if you stop supply, all you get its high prices. I guess one of the aspects of the high price environment now is that it lowers the hurdle for new technologies to substitute. So that's a positive from a green investing point of view. There's not many stocks in the Australian market, but overseas you are seeing strong demand for solar stocks in the US, a lot of offshore wind companies in Europe. I think government policy is going to really boost those areas from a macro substitution point of view.

In Australia, you probably haven't seen the framework for the government yet to encourage this in a consistent way. You've got a lot of state ministers wanting increased renewables. But at the federal level, I think we'll wait and see. And it's quite a new government, so we don't know yet. But overall solar and wind are lower cost than coal power, than gas power today technologies. We're not waiting 10 years for the technology. It's really there. It's more getting the frameworks in place that people have certainty to I guess invest because some of these investments can be 10, 20, 30 year timeframes and the payback periods are within that, but not a typical one or two year investment that you might find for smaller areas.

Viral Patel:

Thanks, Justin. Just any thoughts from Brendan on this, especially with airlines and sustainability investing there?

Brendan Mowry:

Yeah. Look, I think it's a really interesting question. I think inherently a lot of the investment that is required to help us transition from where we are today to a zero carbon world is ultimately, there's going to be a cost to that and it's going to have to be borne by somebody. And the question is going to be okay, is that going to translate to lower corporate profits or are those costs going to be passed on to the consumer in which case it's inherently in phrase inflationary?

Justin Teo:

Just on travel, we've seen a lot of sustainable aviation fuel investments and that's sort of a key thing that a lot of US refiners are looking at because it's a higher value added product. But at the moment I believe the cost differentials 4X at a minimum for that and you can't cure it ever in the world. So that's something where as much as you want to do that long haul flight, they've got to figure out a way to get that capacity at a lower cost.

Viral Patel:

Thank you. Monique?

Monique Rooney:

Yeah. On the property side, look, property in general is a very large emitter of greenhouse gas emissions. I would say that the rates have probably been quite ahead of the curve on I guess the sustainable practises and some are already reaching their net zero targets already. But look, I think increasingly today as their customers are also more conscious of their carbon footprint, they're having to invest in this. And I think it also, certain asset classes, they become obsolete by not. So certainly in office, you've seen people flocking to newer buildings and more green, sustainable buildings as well where, for one, they're at much higher occupancy where the older stock is seeing a lot more vacancy and the idea as well as, from evaluation standpoint it's still to be tested, but you can probably also reach a premium in value by being green and more sustainable.

Certainly in industrial as well, it's a big focus. Again, investing and doing as well net zero developments. I think again, it comes down to the customers wanting to reduce their footprint. And so look, it is a big focus of all the property companies and just as well so they kind of stopped becoming obsolete in future as suddenly people focus more on it. And that does come with a cost as well. But the idea and hope is that they can recuperate that by a high valuation premium for those buildings essentially.

Viral Patel:

Thanks, Monique. And the last question, Justin, I'm going to ask you, given most people have not travelled for over two years now. You've done the energy trip to the US. And I know from signing your approvals, the air fairs were definitely a lot higher. But what was it like travelling, getting on planes, capacity, utilisation, whatever?

Justin Teo:

It was really full. I think I had to go a day earlier because there weren't enough flights out of Sydney. I flew Sydney, Brisbane first to get out of the country to get to the US. Ultimately even in domestic US flights, they were packed. I think to some degree what Brendan was describing domestically, the airlines are doing yield management. They're waiting to fill those seats. They're cancelling flights to consolidate them together. And the fuel costs rise is definitely being passed through to consumers. I think that's something where the willingness to travel is still there. And also from the hotel level, we definitely haven't increased our policies and hotel prices have definitely gone up 10, 15% from what I remember sort of three years ago when travelling for work.

But the interesting aspect is at a global mining conference in Miami, there were 700 people and there were like 400 corporates, 300 investors. And you're seeing a lot of people get back on the road and really want to meet these companies. And sometimes it's quite hard to realise what you lose over that Zoom period. But you can get a lot more I think from your meeting in person and the effectiveness of those meetings and doing due diligence, going to actual sites. So that seems like a bit of a rebound in sort of corporate travel kind of thing. But it's definitely not gotten easier to travel. They're still testing in various countries and you just got to make sure you're wearing a mask when you can.

Viral Patel:

Great. Thank you all and thank you to all the clients for joining. We appreciate as always your business and always happy here to share our thoughts and insights and ideas. Thank you all. Have a good afternoon.