Although there remains a great debate over the issue of a bubble ready to burst in the Australian property market, the evidence appears to support a slowing.  Housing starts here in Australia fell almost 13% in 2011 and are forecasted to fall another 5.9% in 2012, according to the Housing Industry Association (HIA).

Home prices are falling with some spruikers crying out this is the beginning of the end while others suggesting prices are stabilizing.  The number of Australian homeowners at negative equity – they owe more on their homes than the home’s current value – is also creeping up, reaching 2.4% at the end of 2011.  Reflecting the regional disparities in Australia’s property market, an astounding 22.6% of homes in Far North Queensland are in negative equity.

At the heart of the debate over bursting bubble versus slowdown/consolidation is the undeniable fact Australian home prices have exploded like nowhere else in the world.  The following chart shows home price appreciation in Australia versus the United States over the last century:

This chart shows why economists and investment experts outside Australia are more bearish on the Australian property market than many of their Australian counterparts.  Simply put, housing prices here actually appreciated more than in the US and even after the initial shock of the GFC resumed their upward momentum.

Outsiders see continued northward movement as unsustainable while many of our experts sound the refrain that things are different here.  Skyrocketing home prices is only part of the bubble recipe.  Another issue is household debt.  How do Australian households compare with households in other major stgeloped countries?  The first graph shows household debt as a percent of national GDP (Gross Domestic Product.)

Note this chart runs through the second quarter of 2011.  At that point, Australians households had the highest household debt to national GDP of any of the world’s top ten economies; and the lowest level of government debt.  However, even at that point Australians had begun to reduce household debt and increase savings.  The next chart takes household debt to the level that really matters – debt to disposable income, not national GDP:

You can see a gradual deleveraging process began in late 2008 and continues to this day.  Bubbleologists see this as a sign of fire and brimstone as Australians shy away from purchasing homes and apartments in favor of increasing savings.  Those who believe “she’ll be right mate” claim this is evidence fewer Australians will default on their existing mortgages; and of course higher savings are good for bank balance sheets.

Here is a graph showing the savings to disposable income ratio of Australian households:

In summary, housing starts and housing prices are dropping, as is household debt.  How does the average retail investor make sense of all this in light of the crescendo of clashing opinion?  How can one expert from the US predict a 60% drop in Australian home prices while some Australian experts predict a housing recovery by 2016 at the latest?

Everyone is looking at the same set of facts, yet drawing different conclusions.  In some cases, the disparity is due to vested interest.  Facts can be interpreted in different ways, and spruikers will spin those facts in the light most favorable to their interests.  As an example, one of the reasons cited often as to why our housing market has stayed buoyant so long is the fact our banks keep mortgage loans on their books.  While this limited the wild speculation that took place in the United States, it also puts our banks at risk if demand for the mortgage loans they rely on so heavily drops dramatically, and if those loans start to go bad.  Check the financial statements of Australia’s big four and you will see residential property loans account for a substantial majority of their balance sheets.

Banks and real estate professionals have a vested interest in painting our property market picture in colorful hues.  Foreign investors on which our banks rely so heavily draw from experiences in their own countries and paint a different picture.

In a recent interview with the Australian Spectator, bond king Pimco’s head of Australian operations said that his colleagues in the United States believe the Australian property market is the most overvalued market on the planet.

Australian bubble proponents point to a growing chorus of international sentiment agreeing with that view.  Sentiment is the key to this picture.

You have heard it said that perception is more important than reality.  If people believe something is true, the facts do not matter.  Consumer sentiment here in Australia is dropping as anxious Australians watch the gradual downward movement in house prices.  Some react by putting their property up for sale to get out before the big crash, thus increasing the supply of available homes.

Meanwhile, potential buyers look at the same picture and hold off buying for fear of continued downward movement, thus decreasing demand.  And so the downward spiral can pick up speed, based at least in part on sentiment.

Lest we forget, in response to the GFC the government flooded the property market with inexpensive loans via the First Home Buyers Grants.  The expiration of those grants contributed to falling prices, in the eyes of many experts.  But as you can see from the debt to GDP ratio chart above, our government debt is low enough that if need be the government can step in again.  If the gradual decline morphs into a cliff diving drop, the government is likely to step in, amidst howls of protest.

They will do this if for no other reason than to prop up the most crucial victims of a bursting property bubble – the banks.  Our banks rely on foreign investors to generate the capital needed to make the mortgage loans that fuel their present profitability.  The investors who buy the securities our big four banks sell already know the banks are deeply beholden to the residential property market.  If sentiment in favor of the belief a major correction is on the way persists and rises, they will demand higher interest rates.  Thus the banks are at risk both from declining revenues from loans and increasing costs of borrowing.

The analyst community in Australia is still largely positive on the big four.  However, an average retail investor looks at the home price appreciation chart above and has to wonder whether that kind of explosive growth can continue.  If you as an investor believe it cannot, ask yourself how the big banks can grow in the future.

The following table looks at some valuation ratios, performance indicators, and growth forecasts for the big four banks:

Company (Code) P/E Dividend Yield ROE EPS 2 Yr EPS Growth Forecast
Australia & New Zealand Banking Group (ANZ) 10.87 7.2% 15.2% $2.10 6.0%
Commonwealth Bank of Australia (CBA) 11.42 6.3% 18.5% $4.39 2.7%
National Australia Bank Limited (NAB) 9.93 7.7% 13.1% $2.43 5.6%
Westpac Banking Corporation (WBC) 11.04 7.1% 15.1% $2.02 2.6%


The ASX Financial Sector has an average P/E of 10.47 and Dividend Yield of 7.0%.  None of the big four have particularly compelling P/E ratios or dividend yields although three out of four have ROE’s above the value investing benchmark of 15%.  Again, the real issue with the banks is from where future growth will come, given the certainty of at least a short term property market slowdown and the potential of a property market crash.  

ANZ and NAB have forecasted EPS growth of over 5% over the next two years.  Of the two, ANZ may be the better choice given their “Super-Regional” strategy of expanding into Asian markets.  No other bank is doing this and although it remains to be seen whether or not ANZ will be successful, this strategy can protect them from a major downturn in Australia.

Given the slowing property market, the bank credit downgrades, and the recent evidence of bond buyers demanding higher interest rates in troubled markets like Spain, it is surprising that only one Australian analyst has a SELL rating on a member of the big four – WBC.  Indeed, market participants appear to be ignoring the link between the big banks and an increasingly distressed Australian property market.  Here is a one year price chart for the two banks with the highest growth forecasts, ANZ and NAB:

After a difficult year in 2011, these two banks have been in an upward trend throughout 2012.  It is hard to ignore the respectable dividends and historical earnings performance of the big banks, but can investors afford to continue to ignore the growing reality of a slowing property market?

While the market has been kind to the banks in 2012, the same cannot be said for the builders and suppliers.  Here is a one year price chart for two of Australia’s major suppliers of building materials – Boral (BLD) and Brickworks (BKW):

Both these companies have seen declining profits and lowered guidance since the property market slowdown first reared its ugly head in 2010.  Now they are facing more flooding and the wettest April in decades in the greater Sydney region.  Suppliers of building fittings are suffering as well.  However, as is always the case in difficult economic times, there are investing opportunities when there is “blood in the streets.”

The following table contains 7 Australian companies supplying the property market.  Some may have long term potential while others might best be avoided at this time.  Let’s have a look:

Company Code Share Price 52 Wk Lo 52 Wk Hi Div Yld 2 Yr Div Growth Forecast 2 Yr EPS Growth Forecast
Adelaide Brighton Ltd ABC $2.98 $2.22 $3.28 5.8% 7.9% 6.8%
Alesco Corporation Ltd ALS $1.54 $1.0 3.35 6.7% 12.7% 16.1%
Brickworks Ltd BKW $10.35 $8.86 $11.40 3.9% 1.4% 7.0%
Boral Ltd BLD $3.75 $3.13 $5.13 3.8% 10.4% 10%
CSR Ltd CSR $1.69 $1.64 $3.13 5.9% -55% 4.2%
GWA International Ltd GWA $1.94 $1.84 $3.35 9.2% 0.0% -12.7%
James Hardie Industries JHX $7.3 $4.66 $7.99 59.46%


In comparison to the banks, you can see from the table the building suppliers are closer to their 52 Week Lows than their Highs.  Going forward, the stocks to watch should be the ones with high growth forecasts and the ones to avoid are those with low growth forecasts.  This assumes, of course, some degree of validity to the forecasts.  Intelligent investors know to research the sources of growth for themselves.  In particular, one needs to look for diversification within the company both in terms of products and geographical market locations.

Let’s begin with what appear to be the best and worst performers – JHX and GWA.  Based on the following chart of one year share price performance, it would appear market participants agree with that conclusion:

James Hardie (JHX)

Chart: Share price over the year to versus ASX200 (XJO)

While James Hardie is well known to Australians for its asbestos filled past, these days it makes fibre based cement products used for internal and external industrial and residential new construction and remodeling.  Their products are hi tech for the industry and are in fact patented.  They have manufacturing and distribution facilities in Australia, the US, New Zealand, and the Philippines.  They serve the European market as well.  Their products cover an impressive array of building applications, from tile underlayment to siding and fencing.  In better days 80% of revenue came from the US market where they enjoy a dominant market share.  That was considered a liability as the US housing market collapsed.  However, 45% of their US business comes from remodeling, not new construction, and the US is surprising everyone with continued signs of a gradual recovery.

GWA Group (GWA)

Chart: Share price over the year to versus ASX200 (XJO)

GWA supplies building fixtures and fittings to household residences and commercial buildings.  Although their product line includes heating and cooling and door access systems, they are best known for their kitchen and bath products, especially their innovative toilets.  However, they are exclusive to Australia and derive 85% of revenue from residential construction and remodeling.  Recently their CEO Peter Crowley made the candid statement that in his view, any recovery in the Australian housing property market “appears to be some time off”.   The company lowered guidance and the share price suffered as downgrades followed.

Brickworks (BKW)

Chart: Share price over the year to versus ASX200 (XJO)

Brickworks is Australia’s largest manufacturer of bricks and related products.  Although they operate only in Australia and New Zealand, they also derive revenue from a Land and Development Division and an Investments operation via their 42.85% shareholding in Washington H. Soul Pattinson (SOL).  In contrast to GWA, the CEO of Brickworks, Rob Millner, expressed confidence in the future following his company’s reporting of an 18% decline in profit for half year results from the same period last year.  Here is what he said – “We believe we are now close to the bottom of the building cycle and anticipate a recovery in housing construction activity in the years ahead.”

Boral (BLD)

Chart: Share price over the year to versus ASX200 (XJO)

Boral makes a variety of cement based and other construction building products for Australian and US markets.  They recently completed the acquisition of a plasterboard operation in Asia, increasing their geographical diversification.  By virtue of their product line, they should get a boost from rebuilding projects in Queensland, which is not affected by the overall property market decline.  However, whether an increase in revenue from their infrastructure products like cement, concrete, masonry, and asphalt is enough to fill the gap left by the residential property construction downturn is problematic.  

Adelaide Brighton (ABC)

Chart: Share price over the year to versus ASX200 (XJO)

Adelaide Brighton is Australia’s leading producer of lime and the second largest producer of cement, but it is geographically limited to Australia.  However, lime is needed in the resources sector and their position as a cement supplier gives hope to investors provided infrastructure stgelopment in the resources sector and other areas of Australia continues.

Alesco (ALS)

Chart: Share price over the year to versus ASX200 (XJO)

Alesco has a diverse product line, but all serve the residential and commercial construction market.  In addition, their markets are limited to Australia and New Zealand.  It is interesting to note that despite these issues, analyst opinion about this company repeatedly refers to ALS as well positioned to benefit from a turnaround in the property market.  You will find the same opinion voiced for BLD, BKW, and ABC.

CSR Limited (CSR)

Chart: Share price over the year to versus ASX200 (XJO)

CSR is diversified in three divisions – Building Products, Aluminum, and Property.  In theory the diversity should have helped but in practice falling aluminum and property prices have failed to deliver.  In addition, the Australian dollar has increased import competition in their glass and insulation segments.

Although JHX has a competitive advantage with their technology and recently acquired an American company engaged in a new form of cross sectional fibre glass composite materials, opening a potential major new business in the United States; the fact remains their future growth depends largely on the US property market.  However, they are the world leader in fibre cement backerboard and siding, and their proposed expansion into fiberglass products bode well for the future.

Truth be told, all these companies may recover when the property market does.  Clearly, there is a difference of opinion on that, with one CEO proclaiming a bottom is at hand while another sees no sign of recovery in the near future.

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