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Rudi’s August 2017 Review

Feature Stories | Sep 21 2017

Download related file: FNArena-Reporting-Season-Monitor-August-2017

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

Post August Broker Research Nuggets

By Rudi Filapek-Vandyck, Editor FNArena

Local reporting season in August wasn't great, rather disappointing really, with banks and resources companies performing okay, but industrials revealed their soft spots, in the view of Deutsche Bank. The challenge for the market ahead is FY17 might be as good as it gets.

In practical terms, the analysts suggest a subdued reporting season means the local share market is in dire need of an international, macro-driven catalyst to decisively move higher. They still believe 6000 for the ASX200 by year-end is possible, but then their target for June 30, 2018 also sits at 6000.

Deutsche Bank strategists do point out current forecasts are that profit growth shall slow significantly in the year(s) ahead, which explains why FY17 growth has likely marked the peak, for the time being, but they also note if commodity prices remain steady at current levels, this will provide a big boost to profit forecasts, allowing resources companies to still achieve decent growth.

Deutsche Bank's overweighting towards "value" stocks in August didn't work out, but the strategists remain overweight Resources. Other observations made are that conviction among local analysts seems low, high growth, high PE stocks performed well, but commodities related exposure trumped all, while many of the "cheap" stocks (telcos, retailers) simply became cheaper in August.

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Equity strategists at Citi share the view of their peers at Deutsche Bank. On their assessment, August results have brought the share market back down to earth. Outside the resources sector, Citi found little to cheer about, but the strategists remain confident higher for longer commodity prices will translate into more profits for the sector, and this underpins the forecast the ASX200 should still be able to reach 6400 by mid next year.

The table below shows how forecasts have changed at Citi pre- and post August reporting season. The strategists draw confidence from the fact that growth forecasts have become more realistic, while staying positive, and the outlook for reasonable return (double digit percentage total for the year ahead) should continue to support Australian shares.

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Analysts at Wilsons believe it was a reporting season in which quality proved its mettle, and outperformed. This including many of the companies on Wilsons' Conviction List, they point out.

Amongst the stand-out results were, on Wilsons' assessment, Afterpay Touch ((APT)), MYOB ((MYO)), Autosports Group ((ASG)), Noni B ((NBL)), Citadel Group ((CGL)) and Zenitas Healthcare ((ZNT)).

For the most disappointing result of the season, Wilsons analysts point at Mayne Pharma ((MYX)) which subsequently was downgraded to Hold with forecasts cut -20-25%.

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On Goldman Sachs' assessment, relative to consensus expectations the August 2017 reporting season was one of the weakest statistically in a dataset that goes back 22 years. The analysts found few genuinely good news stories, but a long list of stocks that de-rated significantly on the back of disappointing updates and analysts reducing forecasts.

Not helping matters is that implied margin expansion in market consensus forecasts might still be too optimistic. Goldman Sachs suspects further reductions might become necessary as August revealed Australian firms are facing rising wages, higher input costs (power in particular) and rising competition.

While increasing capex intentions have been mentioned as one of the season's positives, Goldman Sachs analysts note "a large portion of the spending appears to be being directed to defend existing positions or to offset rising cost bases suggesting incremental returns will be well below the market's current return on capital".

The analysts note dividend growth is now expected to be negative in twelve months' time, though admittedly Telstra's ((TLS)) big cut has a big impact on the general numbers.

As shown in the graph below, Australian companies are still returning more cash to shareholders (10% above the decade average) and they continue underspending on M&A and on capex.

Contrary to the general euphoria (in some corners) about capex intentions picking up, Goldman Sachs points out total capex in FY17 was -5% below the level spent in FY07; that's ten years ago. In contrast, total dividends paid out were 43% higher. One of the culprits in this story are, of course, commodity related companies; see graph below.

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Stockbroker Morgans found the August reporting season "steady but uninspiring", accompanied by the observation the stock valuations that investors are paying for earnings remain elevated. Morgans cautions against expectations of above-average returns, but at the same time, there are still plenty of good news opportunities out there, acclaims the stockbroker.

Stand-out opportunities, in Morgans' view, include Ansell ((ANN)), IPH Limited ((IPH)), PWR Holdings ((PWH)) and Jumbo Interactive ((JIN)).

Further putting a dampener on potentially too rosy expectations, Morgans is of the view that positive economic data have thus far failed to translate into cyclical tailwinds and as such the Australian share market is lacking a genuine catalyst for the time being, probably meaning the market will remain range-bound for now.

Post August Share Price Impact

The impact from companies reporting their financial results extends much longer than the first few days post market update. Deutsche Bank analysts reminded investors about the lasting effect on share prices after having delivered a "beat", a "meet" or a "miss" during reporting season.

In simplistic terms, companies that "beat" expectations in August typically outperform by 2.5% over the first week after the release; and then by an additional 3% over the following six months. These numbers are averages derived from backward-looking data over the past decade.

In contrast, the best a company can hope for in case of a "miss" is for its share price to keep up with the market over the subsequent six months.

Deutsche Bank research also shows that if a company manages to "beat" expectations, but its share price fails to outperform, the next six months are likely to continue that underperformance.

The strategists put forward their own favourites among companies that delivered a "beat" in August: Medibank Private ((MPL)), Oil Search ((OSH)), Santos ((STO)), Star Entertainment ((SGR)), Tatts ((TTS)), Flight Centre ((FLT)), Fortescue Metals ((FMG)), GPT ((GPT)), Orora ((ORA)) and Perpetual ((PPT)).

August Reporting Season: Costs & Capex, Mining & Dividends

By Rudi Filapek-Vandyck, Editor FNArena

Reporting season is always a subjective experience. Most investors observe it through the prism of their own portfolio. Post August 2017 this means most feel like they witnessed a rather underwhelming performance with numerous disappointments stemming from dividend paying non-resources companies including Telstra ((TLS)), Wesfarmers ((WES)) and the insurers, while many cheap looking stocks became a lot cheaper through the season.

Not helping matters was the eruption of a fresh scandal at Australia's largest index constituent, CommBank ((CBA)), which dragged down the whole sector, widely owned CBA shares in particular.

In the end, what transpired was a reporting season that wasn't as bad as it looked like after the first two weeks. Many disappointments were delivered by large cap, household names, including Suncorp ((SUN)), Insurance Australia Group ((IAG)), CSL ((CSL)), Ramsay Health Care ((RHC)), Adelaide Brighton ((ABC)), Harvey Norman ((HVN)), James Hardie ((JHX)), ResMed ((RMD)), Challenger ((CGF)) and Magellan Financial ((MFG)) – this weighed on investor sentiment generally.

The disappointment of the season carries the signature of Telstra, with the subsequent sell-off causing even more pain for suffering shareholders.

Telstra shares were certainly not the only one that looked "cheap" prior to August, and then became a lot "cheap-er"; Mayne Pharma ((MYX)), Healthscope ((HSO)), iSentia ((ISD)), Vocus Communications ((VOC)), Sky Network TV ((SKT)), Japara Healthcare ((JHC)), Australian Pharma ((API)), CSG Ltd ((CSV)), The Reject Shop ((TRS)),.. the list is extensive with sharp share price movements to the downside popping up on a daily basis.

In the end, share price outperformance came from AREITs, resources (both miners and energy) and from high PE growth stocks that didn't disappoint, such as Carsales.com ((CAR)), Orora ((ORA)) and Treasury Wine Estates ((TWE)).

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Expectations were high, and execution was far from flawless. Even those large bulk miners, swimming in cash and determined to pamper long suffering shareholders, couldn't quite meet analysts' expectations. But investors liked the share buybacks, the extra dividends, the asset sales and the promise of financial discipline.

Strip away the buoyant mining sector, however, and we see a corporate Australia in distress. Rising costs are a genuine problem, not because of wage pressures, but due to higher electricity bills and a much stronger than projected Aussie dollar. Competition and disruption are also key determinants.

These are the reasons corporate Australia is returning focus towards investments and capital expenditure again; which may be good news for GDP numbers and political grandstanding, but in the share market much of the spending done is defensive in nature (i.e. to stay competitive and relevant) and thus not necessarily good news for shareholders. Think Telstra, Seek ((SEK)), GBST ((GBT)), and Suncorp.

This is why guidances for the year ahead proved rather underwhelming, and why analysts have been busy cutting their forecasts.

The largest victims have been dividend investors and bargain hunters. On average, dividend payments have held up well this past season, but this masks the fact that resources companies stepped it up, including many a gold producer. In the background, a number of the trusted dividend paying names announced cuts, including Telstra, G8 Education ((GEM)), Insurance Australia Group, Harvey Norman, and others.

All in all, dividend payouts are clearly under pressure from traditionally trustworthy dividend paying sectors telecom, energy and healthcare.

Separating the diamonds from the dogs is not always straightforward, and share price responses are not always a reliable indicator, but near universal recognition has shown up for strong, high quality "beats" delivered by Bendigo and Adelaide Bank ((BEN)), Cimic Group ((CIM)), Fortescue Metals ((FMG)), IOOF Holdings ((IFL)), Janus Henderson ((JHG)), Orora, Carsales.com and Sydney Airport ((SYD)).

Stand-out performances among smaller cap stocks include Altium ((ALU)), Lovisa ((LOV)), WiseTech Global ((WTC)), Reliance Worldwide ((RWC)), oOh!media ((OML)), Smartgroup Corp ((SIQ)) and SG Fleet ((SGF)). The energy sector, under continued pressure from a lower-than-projected oil price, put in a better-than-expected performance, with cost control a major factor. Not surprisingly, the sector put in a positive performance in a month when dividends contributed 0.8% of the total 0.71% return for the ASX200.

Universally acclaimed shockers and unsettling disappointments came from BlueScope Steel ((BSL)), Crown Resorts ((CWN)), Challenger, Domino's Pizza ((DMP)), Healthscope, Insurance Australia Group, James Hardie, and, of course, Telstra.

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Each reporting season contains two important factors that should have investors' attention:

-How do companies perform and what is their outlook?
-How does the financial performance and outlook impact on analysts' ratings, valuations and forecasts?

The first item wasn't that bad given FY17 growth achieved was the best on record for a long time. Depending on what methodology used, average profit growth was either circa +17% or +25% and either number is well above average. They are both well above the tepid numbers recorded in each of the four reporting seasons post 2014 and prior to February this year.

But actual performances proved below expectations in many cases; as such they triggered reductions in analysts' forecasts. The fact many guidances (in those cases where companies actually provided one) proved rather uninspiring further weighs on estimates for FY18 and FY19. Low to mid single percentage growth seems to be the new normal, though upside exists from higher-for-longer commodity prices, in case there's no weakness on the horizon.

Outside the resources space, however, the bias seems to the downside. And growth projections already are low.

In terms of the actual numbers generated, after keeping track of 319 companies that reported in August, FNArena stats show "beats" and "misses" were relatively equal, percentage wise, this season at circa 27%. This puts the percentage in "misses" equal to last reporting season in February, but these numbers remain high by historical standards; 27% is the highest number recorded since August 2013 when FNArena first started tracking in-season corporate performances.

On the other hand, 27% in "beats" is low when February last had 35% and prior seasons never fell below 30% with one exception; August 2013 which generated the lowest percentages on record for both beats and misses at 25% and 19% respectively.

So the general perception is correct in that more companies failed to impress while less companies managed to muster a positive surprise. The average increase in price target, at circa 1.80% is higher than the 1.36% generated in February, but below 2% is nothing to get overly excited about.

A really good season is when the average target increases by 5%. Though such number certainly seems out of reach in the current low growth environment with many financials and industrials struggling to withstand pressure on margins.

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A special mention goes out to All-Weather Stocks and High PE growth stocks; many of which equally failed to shoot the lights out this season, likely indicating the pressure on profit margin this time around is pretty universal, and difficult to escape from.

But while failures and subsequent sell-offs for a stock like Domino's Pizza receive a lot of attention, and I-told-you-so knee-jerk responses from sideline commentators, a number of structural growth stories certainly were more than just validated this season, including by a2 Milk ((A2M)), Corporate Travel ((CTD)), Treasury Wine, WiseTech Global, Altium, ARB Corp ((ARB)), Bapcor ((BAP)), Cochlear ((COH)), Costa Group ((CGC)), InvoCare ((IVC)), NextDC ((NXT)), Orora and Webjet ((WEB)).

Instead of trying to figure out whether perennial disappointers such as Healthscope, iSentia, The Reject Shop or Vocus Communications have finally sunken deep enough to represent "good value", investors might be doing themselves a far better favour by trying to use any share price weakness to on board of a proven growth trajectory that has much further to run.

Amongst the lesser known names, a number of smaller sized companies are creating a positive legacy full of future promise, including Apollo Tourism & Leisure ((ATL)), Australian Finance Group ((AFG)), Autosports Group ((ASG)), Blue Sky Alternative Investments ((BLA)), Class ((CL1)), Hub24 ((HUB)), MNF Group ((MNF)), PWR Holdings ((PWR)) and Service Stream ((SSM)).

(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.)  

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website. 

P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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