August Reporting Season Preview: Potential Beats & Misses

This story features CSL LIMITED, and other companies. For more info SHARE ANALYSIS: CSL

In this week's Weekly Insights (published in two parts):

-August Reporting Season Preview: Potential Beats & Misses
-Conviction Calls
-Goldman Sachs Initiates Healthcare
-Rudi Talks – Uncomfortable Truths About Investing
-Rudi On TV
-Rudi On Tour

[Non-highlighted parts will appear in Part Two on Thursday]

August Reporting Season Preview: Potential Beats & Misses

By Rudi Filapek-Vandyck, Editor FNArena

As the wide gap in valuations between "growth" and "value" stocks continues to dominate the Australian share market, general views and opinions from stock market experts have opened up a new Grand Divide.

When exactly are we going to witness the Big Switch out of popular winners into cheap looking market laggards?

Back in January, investors had decided to cautiously take some money off the table, paring back share prices in high-flying, popular growth stocks before their interim results releases were due. But as most of them outperformed expectations, soothing general discomfort about elevated valuations, fully valued, High PE stocks turned themselves into the undisputed winners of the February reporting season.

Yet another frustrating experience for those whose mandate and mindset is restricted to buying into cheaply looking, if not beaten down, out of favour share prices. It has been a tough five years, and February did nothing to sooth the pain.

Five months later and the Grand Divide remains alive and well. Top of the Pops benchmark CSL ((CSL)) refuses to sink well below $200, and we could easily use Macquarie Group ((MQG)) -still above $120- or Cochlear ((COH)) -still above $200- as an equally fitting example, though smaller cap technology stalwarts including Altium ((ALU)), WiseTech Global ((WTC)) and Appen ((APX)) have seen the pullback everybody had been waiting for.

Time For The Big Switch?

If it were up to stockbroker Morgans, investors should divest more High PE stocks and re-allocate the proceeds into "value" stocks including mining, energy, staples, media and selected retailers. Morgans is convinced that a switch away from popular High PE stocks into forgotten about and ignored low PE stocks is but a catalyst away, and every week the switch doesn't occur is one week closer to when it will actually happen.

It is such mindset that leads Morgans to suggest that CSL is primed for failure & punishment this reporting season, a view categorically denied by multiple analysts elsewhere. Numerous sector reports in recent weeks have come out in support of owning shares in healthcare leaders CSL and ResMed ((RMD)). Analysts at Wilsons simply declared: those are the stocks investors buy high and watch them go higher.

Instead, many see a rather mixed picture among healthcare services providers and smaller cap peers. Wilsons thinks Mayne Pharma ((MYX)) is a prime candidate for disappointment. Others nominate Ramsay Health Care ((RHC)), but Cochlear is also mentioned here and there.

Index With No Fuel Left?

Whatever the detail and specifics, it appears few dare to predict this year's August reporting season will provide sufficient fuel for the ASX200 to break out to the upside. Stockbroker Morgans thinks rotation will become the defining feature, with the major index range bound as a result.

After all, the market's average PE ratio sits at just under 16x with the average for high performing, sustainably looking industrials stocks above 20x. This ain't no 2009 bottom fishing exercise, to put it mildly.

Strategists at Morgan Stanley hold the exact opposite view: share market laggards, in their view, are going to prove why they have been lagging and why their share price valuation is nowhere near the likes of ResMed and CSL. Those super-duper high quality performers, on the other hand, are most likely to perform, but less likely to significantly outperform which also means the index's upside potential remains restricted; but without the rotation Morgans is craving.

Investors should note Nanosonics ((NAN)) is also mentioned multiple times for potential disappointment this month. In stockbroker's Morgans defense, ResMed did report on Friday and the result wasn't quite what most analysts had penciled in, in particular with the stock having been nominated multiple times for its upside surprise potential. The share price has since seen weakness, though by no means to the extent of what stocks like Janus Henderson ((JHG)), Integrated Research ((IRI)) and Ardent Leisure ((AAD)) had to endure after they delivered a negative surprise recently.

Earnings Growth Robust, Albeit Slowing

In general terms, average EPS growth should again remain well above historic averages, but mainly because of ongoing tailwinds for miners and energy companies. Strip these out and there remains an underlying net profit growth of circa 8%, which is far from bad given the banks continue to depress the overall average. It is also markedly below the double digit growth pace from FY17 and equally well below the double digit pace witnessed in offshore markets.

Bifurcation remains the key word when it comes to the Australian share market, and August is widely expected to add further evidence to this. Key question then remains: are market expectations low enough for under-pressure laggards to positively surprise?

Reading through copious amounts of previews published in recent weeks, it appears here too opinions remain divided. Note, for example, how some analysts are still pointing out that low expectations should make it easier for perennial disappointer QBE Insurance ((QBE)) to meet or beat market consensus, but nobody is prepared to make this a call with conviction.

Too many negative surprises will do that to anyone.

Every reporting season has its marquee disappointment. This time around virtually nobody believes Domino's Pizza ((DMP)) will deliver in line with its own guidance for 20% growth. The share price has moved from $50 to $38, back to $54 and now around $50 again. Clearly, now that everybody is convinced FY18 will be a "miss", the real discussion is what lies in store for the year ahead?

For Domino's Pizza, as well as for most companies reporting this month, investors will be keeping a keen eye out for rising costs, dividends, capital management, and future guidance. Note resources stocks are currently also held for their potential in dividends with further capital management, but Rio Tinto ((RIO)) last week disappointed and the share price was instantaneously pulled lower, even sinking below the 200 moving average.

There is probably a valid message in these observations: miss expectations and thou shalt be punished. If you happen to be concerned about some of the constituents in your own portfolio, there is still time to take some money off the table and reduce risk.

Witness also Seek's ((SEK)) market punishment following an underwhelming guidance for the year ahead. But then, FlexiGroup ((FXL)) shares dropped -13.6% after announcing the new CEO will be leaving, and those shares are still on a single digit PE.

Asaleo Care ((AHY)) remains out of favour and poised to once again highlight the danger of owning high yield stocks while watching the rear view mirror. Just about everyone is convinced here comes one of the monumental cuts in dividends for this reporting season.

Valuations And Risks

Some analysts have made the suggestion this is what most likely will colour the August results season: large pull backs and sharp rallies in individual stocks, but overall not much to write home about in terms of broader market/index movement.

Apart from elevated valuations in selected sectors and segments, investors are worried about the downturn in housing prices and how this might impact on companies and sectors. In some cases, there is the suggestion that a sudden uptick in consumer spending recently might allow companies including JB Hi-Fi ((JBH)), Specialty Fashion ((SFH)) and Woolworths ((WOW)) to deliver a positive surprise, but in case of the former two (and their peers) there is also the big question mark whether this might prove a temporary resurrection only.

Credit Suisse seems convinced the risk for Woolworths and Wesfarmers ((WES)) is to the upside, but in particular so for Premier Investments ((PMV)). Harvey Norman ((HVN)) has been singled out for the most likely negative surprise in the sector.

UBS has a broader framework and likes Woolworths, Treasury Wine Estates ((TWE)), Premier Investments and Adairs ((ADH)) for positive surprise potential. Myer ((MYR)), on the other hand, is once again nominated for a potential disappointing results release.

When The Credit Crunch?

Those who are focused on signals of a pending credit crunch in Australia are seeing signs accumulating. UBS points at declining car sales impacting on Autosports Group ((ASG)) and Automotive Holdings ((AHG)). It is probable this is also weighing on Carsales ((CAR)) with Morgans highlighting Carsales seems the only one in online media that is not priced for perfection.

Morgans also believes any share price punishment for either Domain Holdings Australia ((DHG)), REA Group ((REA)), or Seek will provide longer term opportunity. The stockbroker also points out some of the smaller e-commerce stocks are all cheaply priced, including Redbubble ((RBL)), Frontier Digital Ventures ((FDV)), and iCar Asia ((ICQ)).

In terms of earnings estimates momentum leading into this year's August season, the tide has favoured energy (on higher oil prices), staples and media with overall negative momentum descending upon telcos, consumer services and financials. Regarding the latter, banks carry low expectations, while Credit Suisse has also nominated Computershare ((CPU)), Janus Henderson and Netwealth Group ((NWL)) for a negative surprise.

Janus Henderson proved Credit Suisse was correct with at least one.

Insurers And AREITS

General insurers are definitely enjoying positive operating momentum, but questions are lingering whether QBE can finally deliver a "clean" result; whether AMP ((AMP)) can keep funds outflows limited; whether Insurance Australia's ((IAG)) valuation is pricing in too much?

Among AREITs the general concern is with shopping mall owners' exposure to retail shops, as well as about the future impact from the housing downturn. There is discussion about what is already implied in today's share prices, leading UBS analysts to prefer Vicinity Centres ((VCX)) and Scentre Group ((SCG)) in the sector while seeing risks as to the downside for developers Stockland ((SGP)) and Mirvac ((MGR)).

Others like Morgan Stanley continue to prefer those with an active earnings growth profile, providers of office space, or developers that can use their capital effectively during the downturn. As stated earlier, Morgan Stanley is not so much deterred by high valuations which means Charter Hall ((CHC)) and Goodman Group ((GMG)) in the sector are not by definition seen as off limits simply because of premium share price valuations.

Amcor ((AMC)) has also been named for potential disappointment this month because of headwinds and higher input costs (think oil) but now plans to acquire Bemis Company in the US have surfaced, the outlook from here onwards is defined by this US$7bn transaction.

Winners And Losers

Within a broader context, and drawing opinion from all individual sector analysts, stockbroker Morgans thinks an earnings beat and/or outlook upgrade is most likely to come from Suncorp ((SUN)), Insurance Australia Group, Adairs, Wagners Holdings ((WGN)), Acrow Formwork and Construction Services ((ACF)), Smiles Inclusive ((SIL)), Cleanaway Waste Management ((CWY)) and Kina Securities ((KSL)).

Earnings misses and/or a soft outlook is most likely delivered by Coca-Cola Amatil ((CCL)), Costa Group Holdings ((CGC)), Ramsay Health Care, Automotive Holdings, Michael Hill International ((MHJ)), Vocus Group ((VOC)), Nanosonics, Amcor, Monash IVF Group ((MVF)) and Transurban ((TCL)).

Stocks that remain vulnerable because of elevated valuation, in the view of the broker, include Blackmores ((BKL)), Bellamy's ((BAL)), CSL, Domino's Pizza, Infigen Energy ((IFN)), and Aurizon Holdings ((AZJ)).

Analysts at UBS have nominated the following for a potential positive surprise: Alumina ltd ((AWC)), Ansell ((ANN)), BHP ((BHP)), BlueScope Steel ((BSL)), Domino's Pizza (how's this for a contrarian call?), Downer EDI ((DOW)), Flight Centre ((FLT)), Suncorp and Treasury Wine Estates among large cap names.

Among smaller cap peers the selection consists of: Imdex ((IMD)), Ausdrill ((ASL)) and Webjet ((WEB)).

UBS's research indicates the odds are in favour of a negative surprise from: Domain Holdings, Ingham's Group ((ING)), Primary Health Care ((PRY)), and REA Group among large caps, and from Cabcharge ((CAB)), Retail Food Group ((RFG)), Galaxy Resources ((GXY)), Orocobre ((ORE)), and Syrah Resources ((SYR)) among smaller cap names.

Quant analysts at Macquarie have selected Cochlear, Woolworths and AGL Energy ((AGL)) for a potential negative surprise, while BlueScope Steel, Reliance Worldwide ((RWC)), Downer EDI, IDP Education ((IEL)), Beach Energy ((BPT)), Bapcor ((BAP)), and retailer Lovisa Holdings ((LOV)) have been nominated for their upside surprise potential this month.

Analysts at Wilsons have selected the following stocks for what they call "upside reporting season risk": Afterpay Touch ((APT)), Alliance Aviation ((AQZ)), ARQ Group ((ARQ)) -this is the former Melbourne IT- Bravura Solutions ((BVS)), Mastermyne ((MYE)), MYOB ((MYO)), Noni B ((NBL)), NRW Holdings ((NWH)), and ResMed.

Have been nominated because of "downside reporting season risk": Beacon Lighting ((BLX)), Class ((CL1)), Greencross ((GXL)), Nanosonics, and Select Harvests ((SHV)).

As always, no matter what technique has been used, or how many analysts' insights have been involved, or how much time has gone into these selections, there are no guarantees of a high/moderate/above average accuracy rate.

All shall be revealed in the coming three weeks.

Strap yourself in.

Rudi Talks – Uncomfortable Truths About Investing

Having freshly returned from presentations on the Gold Coast and in Canberra, I can report a recording of my seminar to members of the ASA has been added to the FNArena Talks section of the website.

It shows one hour of introduction, slides, conversation and questions around the main themes that have characterised both share market dynamics and my personal analysis over the past five years.

Not everybody is going to like my analyses, conclusions and observations, which is why the title reads "Uncomfortable Truths About Investing In The Australian Share Market".

Here's a direct link to the recording: https://bit.ly/2Oc5w02 (or visit FNArena Talks)

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows:

-Tuesday, 10.30am Skype-link to discuss broker calls
-Friday, 11am, Skype-link to discuss broker calls

Rudi On Tour

-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10
-Presentation to ATAA members and guests Sydney, on 18 October

(This story was written on Monday 6th and Wednesday 8th August 2018. Part One was published on the Monday in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. Part Two shall be published on the website on Thursday).

(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. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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(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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