As expected, the first half of 2016 proved challenging on the financial markets, and the high volatility on the stock market looks as though it will continue in the second half of the year. What then does the second half of 2016 hold in store? Standard & Poor's Maalot attempts to shed some light.
In income producing real estate in Israel, the S&P Maalot analysts find that the trends and market conditions will make it difficult to raise rents, even for the major companies, in the medium to long term. Some of these trends are weakness in the economy, which is liable to continue, excess supply of office and commercial space, and a rise in online sales, which hurts fashion retailing, and which will radically alter the entire commercial sector in the long term.
The collapse of Canadian real estate company Urbancorp, which brought down the bonds of the other foreign real estate companies that have chosen to raise money in Tel Aviv, severely damaged investors holding these bonds in the first half of 2016. S&P Maalot is cautiously optimistic here, and estimates that in the coming year demand for income producing real estate in the US will continue its moderate rise as a result of slow but stable economic growth.
Residential development: Upward price trend to stay
Anyone who hoped to see a fall in home prices in Israel in the near future will find no cause for optimism from S&P Maalot. "The government's programs for boosting supply on the market and assisting first-time home buyers are likely to have some moderating effect on the rate of price rises in the short term, with the expected rise in the availability of apartments in the 'buyer price' program,'" the analysts write, but add "We shall still see a trend of rising prices in the coming year, although moderate in comparison with 2015, because planning and permit processes are still long, adversely affecting the amount of building permits awarded, because of the shortage of construction workers which lengthens construction times, and because of the low interest rate environment, which supports demand."
S&P Maalot estimates that in the medium term the rate of home price rises will slow significantly, and that we may even see a reversal of the trend, because of growth in supply and gradual normalization of interest rates.
Telecommunications: The Golan Telecom question will be resolved only in 2017
As in previous years, the Israeli telecommunications market has been out of balance in 2016. Continuing intense competition, regulation, and the inauguration of the wholesale market encourage market players to form communications groups operating in several fields.
"The characteristics of the market, particularly the intense competition, are leading the major mobile telephony companies to seek niches that give them a competitive advantage. It seems that consumers have become more indifferent to switching providers given a lack of very attractive offers," S&P Maalot states.
Excluding one-time effects, most of the companies continue to present declining operational performance, with aggregate revenue falling and operating profit being eroded.
Looking ahead, S&P Maalot estimates that 2016 will continue to be characterized by uncertainty, further price competition, and low investment, and that the Golan Telecom saga will be resolved only in 2017. "We see 2017 as the year that could mark the beginning of the turnaround and of greater stability for the players in this market, even if the level of competition remains high."
As far as the more distant future is concerned, S&P Maalot believes that despite the regulator's reservations about the Golan Telecom-Hot deal, the mobile telephony market will one way or another see consolidation into four main carriers. ARPU will stabilize at a slightly higher level than in the past year, but will still remain low in comparison with levels in Europe.
Food retailing: Yeinot Bittan will not bring prices down
The upset in the food retailing market following the collapse of the Mega supermarket chain is still not over. S&P Maalot estimates that in the short term the Yeinot Bittan chain, which has bought Mega, will have to invest large resources in merging stores, refurbishing them, and improving terms of trade with suppliers. The chain will also be tied to employment and rental agreements that are expensive for the sector.
In S&P Maalot's view, the chain will not erode the profitability of the branches it has bought by aggressive price cutting, but it does see competition intensifying in 2017 with the formation and stabilization of an additional major player in the market that will affect same-store sales. All in all, S&P Maalot rates food retailing as a high-risk sector characterized by great uncertainty.
Banking: Progress in cost cutting
Since the beginning of the year, the banks have continued to expand their retail credit activity. "This trend will, in our view, continue in the rest of the year. The banks' streamlining efforts also continue, among other things because of the possibility of obtaining concessions from the regulator on capital adequacy by demonstrating greater efficiency. We have also seen the first offerings of hybrid capital instruments in the spirit of the Basel 3 directives, a trend that we think will continue in the coming years. Beyond that, we believe that the banks will continue to be dominant players in raising long-term debt, in readiness for the Basel 3 liquidity requirements," S&P Maalot's analysts write.
On a global comparison, S&P Maalot finds the Israeli banking system to be mature with stable competitive forces and a level of supervision similar to that in developed countries.
"Profitability is limited," S&P Maalot says, "by the Israeli banks' low operating efficiency by global comparison, among other things because of unions and collective wage agreements that make cost structures inflexible. We believe that the challenging economic environment, which makes it hard for the banks to increase their revenues, will also characterize the near future. Nevertheless, the ongoing improvement in the capital base as a result of regulatory requirements to continue focusing on reducing costs contributes to the strength of the local banks and to creating a suitable cushion for absorbing losses."
Insurance: Zero potential for dividends
The Insurance Index has fallen 23% in the past year, against a backdrop of poor performance by the companies, and S&P Maalot believes that the challenging environment in which the insurance companies are operating will not change for the better in the second half of 2016.
"A further fall in the shekel risk-free yield curve, particularly long term, led to additional substantial growth in insurance liabilities at the expense of profitability, because of the adjustment of the capitalization rate. At the same time, weak returns on the markets prevented capital gains on the assets side, worsening the effect on the profitability of companies in the sector," S&P Maalot writes.
On the start of the process of adopting the solvency regime on the basis of the EU Solvency II Directive, expected in Israel in January 2017, S&P Maalot writes, "Shareholders' equity in the sector will rise substantially, in order to meet the new requirements, which will be especially challenging given the low interest rate and the current operating environment, in which the companies are finding it hard to maintain profitability levels. We believe that this will lead the insurance companies to act to increase their capital in the coming year, including by issuing complex capital and debt instruments recognized as capital for regulatory purposes. The potential for dividends in the industry, which in any case has been low for several years, is now practically zero."
S&P Maalot's review was compiled by Lena Schwartz, Hila Perelmuter, Ofer Amir, Gil Avrahami, Eyal Evron, Tamar Stein, and Beni Peer.
Published by Globes [online], Israel business news - www.globes-online.com - on July 5, 2016
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