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Rudi’s February 2017 Review

Feature Stories | Mar 31 2017

Download related file: FNArena_Reporting_Season_Monitor-February-2017

The story below is a compilation of reviews and assessments published in the aftermath of the February 2017 corporate reporting season in Australia. It comes with the final update of FNArena's Reporting Season Monitor (see attachment).

Feb Reporting Season: Large Cap Come-Back Confirmed

By Rudi Filapek-Vandyck, Editor FNArena

February 2017 was the corporate reporting season that cemented the general come-back of large cap, Blue Chip stocks over their smaller sized peers on the ASX. Sure, Brambles ((BXB)) and Telstra ((TLS)) were amongst the month's stand-out disappointments, but overall the top end of the market delivered more beats and meets than misses, and underlying profit estimates went up, not down.

The latter is a unique in the post-GFC era in which every single reporting season has seen market EPS forecasts fall, never rise, when corporate Australia is unleashing financial results upon the investment community, until February 2017.

As resources and banks generated more beats than misses, strong growth forecasts remain in place, as well as the portfolio rotation that started in 2016, and the preference for large caps over smaller cap stocks.

On Goldman Sachs' calculations, more than $3bn in share buybacks have been announced in February; clearly indicating where board priorities are centred. Hint: it ain't in going out on an investment spree.

On FNArena's final assessment, some 35% of reporting companies beat market expectations. This is near the top of recent reporting seasons though both Feb-16 and Feb-15 showed slightly higher beats (37% and 36% respectively).

Equally remarkable: the 27% in recorded misses was the highest on record thus far.

In addition, the 1.4% average increase in stockbrokers' price targets was near the lowest increase registered since August 2013. Only August of 2015 showed a lower increase of 1.2%.

Overall, it appears the Australian share market is potentially en route to reporting the highest EPS growth post-GFC, could be +18% or higher, but ex-resources there remains a mid-single digit growth outlook only, which is more or less in-line with the experience of the years past.

February Reports: Ultimate Polarisation

By Rudi Filapek-Vandyck, Editor FNArena

The quickest way to put a serious dent in one's investment performance is through buying shares in smaller cap industrial stocks, or so it appears.

Only one year ago disappointing financial performances followed by a decent share market shellacking were still the prerogative of mining and energy companies. Smaller cap industrials were soaking up the limelight with solid growth numbers and an oozing confidence to keep investors on board.

Seldom has the contrast in operational momentum between the two switched so markedly. February 2017 has become the corporate reporting season that allowed resources stocks to rise above the field, carried by elevated commodity prices on top of stringent cost control and accelerated debt reductions.

Shareholder dividends in Australia are firmly on their way to a new record high by mid year, and this year's boost is coming from swelling cash piles among the likes of Rio Rinto ((RIO)), BHP Billiton ((BHP)), Fortescue Metals ((FMG)), South32 ((S32)), and many others.

The swift turnaround for resources companies has been accompanied by better results for Big Banks, and for large, Blue Chip stocks in general.

Which makes it rather remarkable that smaller cap industrials, the Champions from 2015 and the first half of 2016, have quickly become the Killing Fields for many an investor's unfounded hope and misguided expectations. Land mines and booby traps. There were so many around this season, I'd have to hire a dedicated team to keep track of them all (see further below).

Contrarian Good News Stories

Good news stories a-plenty this February, in particular among resources companies for which debt and balance sheet stresses disappeared alongside higher-for-longer commodity prices. But most of it had been widely anticipated. After all, most commodity prices are public knowledge, and available daily. Share prices are no longer dirt cheap, so we need to see a pick-up in general sentiment for BHP Billiton shares to have a genuine crack at $30, but that's what is missing from global markets right now.

The banks did an overall good job in dismissing speculation about the need for additional capital and/or dividend cuts, assisted by extremely low debt defaults. But major bank shares already are trading above consensus price targets.

Hence most of the positive surprises this month came from companies such as CSL ((CSL)), ResMed ((RMD)), Carsales ((CAR)), Amcor ((AMC)), Link Administration ((LNK)), NextDC ((NXT)), Melbourne IT ((MLB)), and WiseTech Global ((WTC)). Their share prices had fallen out of favour and off most investors' radar as large cap banks and resources stocks continued their strong come-back in the second half of last year. This month's financial results proved those absent investors wrong and quick corrections to the upside ensued. We can add Aristocrat Leisure ((ALL)) to this list too.

Meanwhile, while nobody's paying attention, former yield-driven high flyers such as Goodman Group ((GMG)) and Transurban ((TCL)) are establishing a quiet come-back on the back of solid financial performances, and falling bond yields.

The Bear Is Hiding Among Smaller Cap Industrials

Investing under challenging circumstances often turns into a loser's game. No longer are share market returns determined by the profitable investment decisions made, rather they become beholden to the disappointments, the misses, the public punishments and the free fall in share prices that occur instantly.

On Monday, Slater & Gordon's ((SGH)) share price fell yet another -21.88% but general widespread interest in the shares evaporated long time ago. Far more damage will have been caused by the likes of GBST Holdings ((GBT)), Ardent Leisure ((AAD)), iSentia ((ISD)), Village Roadshow ((VRL)), Aconex ((ACX)), RCG Corp ((RCG)), and others. Not to mention larger cap disappointments from Telstra ((TLS)), Magellan Financial ((MFG)), and from Brambles ((BXB)).

In line with past experiences, February 2017 provided ongoing evidence that once a company is gripped inside a bad news cycle, it is not easy to shake off the past and start a new beginning. Probably the most anticipated disappointment this month came from Flight Centre ((FLT)) which released its fifth downgrade in three years, while competitors Webjet ((WEB)) and Corporate Travel ((CTD)) continue to confound the critics and doubters.

Village Roadshow too is building a rather miserable track record, as is CSG Ltd ((CSV)), and OFX Group ((OFX)), and Godfreys ((GFY)), and possibly Blackmores ((BKL)). Looking over the field of casualties, one cannot but reflect back on what has happened to the many growth narratives that inspired many an investor in the years past. The Chinese dining boom. The ageing population. The Chinese tourism boom. From Bellamy's ((BAL)), to Capilano Honey ((CZZ)), to Japara Healthcare ((JHC)), to Mantra Group ((MTR)); many an investor who bought into what seemed like a sustainable growth story, and stuck with the narrative, is post February left licking his wounds.

Below is the share price graph of Mantra Group from the past twelve months. It clearly shows a share price that, through ups and downs, is trending from near the top on the left towards the bottom on the right. Not exactly the underpinnings of a raging bull market. The sad observation is many of ASX-listed smaller cap industrials are showing a similar looking price chart.

Other observations that deserve to be highlighted:

-retail remains a heavily polarised experience; few Champions among many battlers; Nick Scali ((NCK)) keeps breaking all the records

-the legal profession continues to disappoint, including Slater & Gordon, Shine ((SHJ)), IPH Ltd ((IPH)), Xenith IP ((XIP)) and Quantm IP ((QIP))

-competition is fierce, and intensifying, inside the telecommunication sector

-Resources might have become the new defensives, the sector never is fully free from operational risks, including at Doray Minerals ((DRM)), Iluka Resources ((ILU)), WorleyParsons ((WOR)), and others.

Note balance sheet weakness has now become a major focal point for investors at WorleyParsons and Village Roadshow. Capital raisings and asset sales should be expected.

Moderately Below Forecasts

As far as corporate profits are concerned, February 2017 has likely been the best interim update since 2010. Usually analysts' expectations are higher coming into reporting season than they come out of it, but this year the skew was towards increasing forecasts, not reducing them.

Assuming no disasters between now and August, FY17 might well be en route to becoming Australia's strongest growth performance post GFC. This year can possibly beat FY11, the last time resources companies enjoyed an outburst in positivism.

Behind those general statistics, however, hides the ugly truth that outside the resources sector, things remain shaky and unpredictable. No room for complacency, as proven by the numerous disasters among smaller cap industrials. The February reporting season is not yet officially finished, so we don't have as yet have final numbers to crunch. But as things seem to be lining up in these final days, earnings beats and misses seem close to FNArena's calculations at the end of the February reporting season in 2015.

Back then, we registered 36% corporate releases beating expectations, while 26% missed market expectations. These numbers each are near the highest in the history of our analysis starting post August 2013. It doesn't take much to see both extremes as yet more evidence of a heavily polarised share market. Key difference: two years ago smaller cap industrials were the shining beacon in a macro-driven, over-enthusiastic local share market. This time around, smaller cap industrials represent a true boulevard of broken dreams and lost opportunities.

The most used expression in February's stockbroker research reports was "moderately below expectations", and various variations on the theme. One given day I opened one broker's daily overview to find that same sentence prominently in the first half a dozen or so assessments inside the report.

There have been many of such "moderately below expectations" corporate releases this month, but investors did not treat all of them equally. Iress' ((IRE)) share price catapulted higher post the release of a slight miss, but there was no such generous treatment for the likes of Hansen Technologies ((HSN)), Bapcor ((BAP)), Altium ((ALU)), ARB Corp ((ARB)), Baby Bunting ((BBN)), or Magellan Financial.

Here awaits potential opportunity for investors daring to go against the grain.

Also, preliminary calculations suggest this month's average increase in stockbroker price targets for companies having reported might be amongst the most tepid recorded since August 2013. This is not necessarily a reliable signal for further share market upside as behind all calculated averages hides a seldom witnessed polarisation in corporate profits and share price momentum.

Special mentioning: the operational leverage inside slimmed down BlueScope Steel ((BSL)) is simply phenomenal.

More Revenues, Less Spending

Analysts at Credit Suisse make the observation that, overall, corporate Australia is guiding towards higher revenues, while at the same time promising to keep a lid on spending. It appears a general scepticism towards sustainability of elevated commodity prices and ongoing desire to please shareholders is outweighing pleadings from the likes of PM Malcolm Turnbull and RBA governor Phillip Lowe to finally embark on a large corporate spending spree.

My personal take on this remains that businesses shall remain reluctant to spend until they experience a genuine, sustainable pick up in demand. Average wage growth remains dismal. House prices may not provide a favourable background for much longer. Investors should note, however, the combination of more revenues and restrained spending is the main reason why Credit Suisse expects the ASX200 to reach 6000 by year-end.

Corporate Australia's frugal attitude towards business spending is, of course, feeding into a record high dividend payout by mid-year, and possibly beyond.

Special note: stronger sales and weaker capex hasn't happened in over ten years in Australia, according to Credit Suisse.

Equally worth noting: most of upgrades to profit estimates are happening among large cap stocks, not necessarily confined to resources only. Commodities analysts have to date not accounted for any growth post FY17.

The latter will be the background battle to determine whether/when exactly resources stocks share prices can look forward towards the next upswing. Is there a follow-up chapter to the present buoyancy, or will it simply remain a temporary phenomenon?

Feb Reporting Season: The Interim Verdict

The quality of a corporate reporting season should always be judged against the background of market expectations, and general trends in share prices. Every investor worth his salt should know by now profit growth is exploding to the upside, but that's predominantly a mining sector story on the back of significantly higher commodity prices from twelve months ago.

Even so, the calendar might suggest we are about two-thirds through corporate results in Australia, fact remains the concentration of corporate releases is very much skewed towards the week ahead. In other words: its still too dangerous to draw any definitive conclusions. Too many reports outstanding can change views and statistics. We'll have to wait until next week to compile a clearer picture.

Nevertheless, the general impression thus far is that most companies are living up to expectations and underlying the general trend in profits and forecasts retains a slight upward bias.

At least, such are the early, and preliminary, impressions as published by strategists at UBS, Deutsche Bank and Macquarie on Monday. Our own observations here at FNArena are slightly different.

Again, any statistics are incomplete, but it remains remarkable that more companies seem to be beating results, but also that more companies seem to be missing the mark. Both percentages to date are potentially en route for setting new records in the short history of the FNArena Market Monitor, in place since 2013.

Among those who clearly beat market expectations were CSL ((CSL)), Amcor ((AMC)), Boral ((BLD)), JB Hi-Fi ((JBH)), Nick Scali ((NCK)) and ResMed ((RMD)). Plus two of three big banks that either released financial results (CBA) or a March quarter trading update (ANZ Bank). The latter hasn't been witnessed for quite a while.

There have already been plenty of disappointments, of course, and savage share price responses have followed. Disappointments often hide in industry dynamics or underlying organic growth rates, which leaves share prices still vulnerable after financial results came out in line with analysts' expectations. Others simply suffered from the fact that share prices already were at elevated price levels.

Observe, for example, how resources stocks have stopped outperforming the broader market even though the sector's corporate performance pushes most others in the shadow.

One observation stands out in that some of the quality industrials that had previously been left to the wayside, because they no longer fit in with the new market narrative, have been able to arrest investors' ignorance with their financial results. Apart from CSL and Amcor, Link Administration ((LNK)) also springs to mind, as well as Class ((CL1)), a2 Milk ((A2M)) and Carsales ((CAR)).

There is also a growing list of former staple portfolio stocks revealing their weaknesses: Telstra ((TLS)), Brambles ((BXB)), Medibank Private ((MPL)), IOOF Holdings ((IFL)), and Tabcorp Holdings ((TAH)). We could even add Wesfarmers ((WES)) to this list, though the conglomerate from Perth has many more options up the board's sleeves to unlock shareholder value.

As per always, there have been the usual punishments, in particular among small cap industrials, where perennial disappointers such as Village Roadshow ((VRL)) remained true to form.

All in all, FNArena has been registering twice as many downgrades in stockbroker ratings for individual stocks than upgrades, but this is no surprise given the rally in share prices over the past five months.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

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