Rudi's View | Sep 05 2018
In this week's Weekly Insights:
-August 2018 Reporting Season: The Final Verdict
–September Index Changes
-Rudi On TV
-Rudi On Tour
August 2018 Reporting Season: The Final Verdict
By Rudi Filapek-Vandyck, Editor FNArena
The August reporting season always provides investors with fresh insights and updates that can be used as input for portfolio adjustments and strategy re-alignment for the year(s) ahead.
Last month has been no exception (definitely not!), but before we get to the nitty gritty of the most recent mass-update on how corporate Australia is faring, let's zoom in on the statistical data first.
As things stand now that the August reporting season is officially over, and we have to assume the bulk of broker reviews and responses are in the public domain, 307 companies in the FNArena universe have reported with 145 (47%) of these companies doing so broadly in-line with guidance and expectations, leaving 87 (28%) to do better and 75 (24%) to disappoint.
Put in a broader perspective, these numbers suggest the overall context for Australian companies has become tougher since February when 37% of companies did better than expectations and 25% disappointed. One obvious conclusion to draw is there has been a noticeable switch to in-line reporting.
That conclusion still stands if we compare with the data gathered from all prior seasons going back to August 2013. In particular the fact that only 28% managed to outperform market expectations while 30% or higher seems the norm, underpins the suggestion it is not easy out there in the real economy.
The 24% in "misses" sits right in the middle of historic comparables, on par with August and February 2016, but also better than each of the reporting seasons since. So less misses and less upside surprises; does this make for a middle-of-the-road reporting season, unspectacular but decent?
Probably yes. Earnings estimates have fallen, as they do most seasons, but Australian companies ex-resources are still expected to continue growing at circa 7%, on average, which is not bad at all compared to the years past. Banks continue to be laggards, while Resources continue to reap the benefits from expansion restraint and higher-for-longer product prices.
Valuations, in general, remain far from cheap, but they have been around present levels for quite a while now. The average Price-Earnings (PE) ratio for the ASX200 is around 15.7x, but this masks the fact many companies with robust growth under the bonnet trade on much higher multiples, and have been for a number of years now.
When we take this into consideration, the number of spectacular misses and subsequent capital punishments has quite arguably remained relatively benign, and August 2018 was not an exception in this department. Yet evidence suggests there is more at work behind historically high PE multiples for selected growth stocks than simply investor exuberance or momentum traders' delight, as some value investors would like us to believe.
Stockbroking analysts issued 83 recommendation downgrades throughout the month (only counting those in relationship to financial results) and 45 upgrades. Back in February, the balance was in favour of more upgrades -88 versus 53- but that is rather the exception. What stands out is the circa 3.46% average increase for consensus price targets throughout the month.
History shows February is usually the season when price targets jump most and when they do, August tends to see much lower increases. Not in 2018. February saw an average increase of 4.3%. Combined with August's 3.46% makes for the highest annual increase since FNArena started keeping records in August 2013.
Most of the increases in February and August this year can be attributed to the high growth, high PE stocks that have kept on performing this year. Think CSL ((CSL)) and REA Group ((REA)), but also Afterpay Touch ((APT)) and WiseTech Global ((WTC)).
In terms of share market performance, the ASX200 Accumulation Index (including paid out dividends) added 1.42% on top of a positive performance in July for a combined gain of 2.83%. For the first eight months of the calendar year total performance has now risen to 7.23%. Again, considering most equity markets outside the US are barely in positive territory or deep into the negative, this does not look like a bad achievement.
One has to acknowledge though, the Australian share market remains one key beneficiary from funds flowing out of emerging markets and this, more than local corporate results, has underpinned share market momentum thus far.
The FNArena/Vested Equities All-Weather Model Portfolio experienced yet again a positive reporting season gaining 3.27% for the month of August, 4.14% for the two opening months of financial 2019 combined and 11.28% calendar-year-to-date. I shall update more in detail about the Model Portfolio later in September.
In my view, the best way to judge how companies are performing is through measuring the impact of their financial report on analysts views and forecasts. And the best measurement of such impact is via consensus price targets.
Which is why these targets are front and centre of FNArena's reviews of corporate results via the dedicated section on the website:
Looking at the share market (or one's investment portfolio) from this angle can trigger a number of fresh insights.
The price target for Commbank ((CBA)), for example, has increased to $73.94 from $73.63 prior to its FY18 release. That's an increase of 0.42%. Given the share price at the time of the release was actually higher, it shouldn't surprise CommBank shares have since been sliding lower (they paid out one final dividend too).
Put in a broader sector perspective, at least the target is no longer falling, even though it might be too early to make robust predictions about the worst of sector challenges now being behind us. It equally serves as yet more evidence for investors the golden years for Australian banks when each reporting season would add several percentages on top of existing targets are not about to resume anytime soon.
On the other hand, price targets for first mover lay-by facilitator Afterpay Touch ((APT)) jumped by an average of nearly 69% to $22.33 post the release of FY18 financials and the announced expansion into the UK. This is also where the stock settled at first, before investors taking profits pushed it lower.
And if we really want to know how bad the latest profit warning by iSentia ((ISD)) actually was, let's consider the price target has fallen to 44c from $1.01; and that's not taking into account this is a stock that has traded as high as $4.85 since it IPO-ed in June 2014, with valuations and price targets sliding ever lower as more bad news and disappointments have accumulated.
G8 Education's ((GEM)) price target has now sunk to $2.36 from $3.03 (-22%). Interestingly, the target for a2 Milk also retreated a little: to $11.50 from $11.72. Telstra's ((TLS)) average target, in contrast to the strong rally in the share price, has now fallen a further -6.5% to $2.95.
And if anyone wonders how disappointing the market update by Origin Energy ((ORG)) really was, its price target has since lost more than -6.5% to $9.54.
Back in February, the big surprise to most commentators was how high growth, high PE stocks continued to deliver, and in many cases managed to still outperform high expectations. The result was for an unusually wild reporting season with many high-flying high PE growth stocks rallying strongly upon the release of financial numbers.
The fact that many share prices had been pared back in anticipation of what surely had to be the (long anticipated) day of reckoning for stocks including Altium ((ALU)), WiseTech Global and Corporate Travel Management ((CTD)) helped creating an environment of wild swinging share prices; mostly to the upside.
August has been no exception, but this time the wild swings have been less about high PE stocks still living up to their promise, though the same core feature still applied -think CSL ((CSL)), Afterpay Touch, and others- but equally so about companies that had been under intense pressure for a prolonged time, finally delivering positive news, even if this was because there was an absence of bad surprises.
And thus this time long suffering shareholders in FlexiGroup ((FXL)), QBE Insurance ((QBE)) and, yes, even Telstra got their fair share of the wild up-swings that have occurred during August. It was not all related to corporate results with TPG Telecom ((TPM)) announcing a tie-up with Vodafone Hutchison Australia and numerous acquisitions being declared, including by Northern Star Resources ((NST)), Pact Group ((PGH)), Amcor ((AMC)), Orora ((ORA)), and others.
The mentioning of the three packaging companies is no coincidence. Packaging has been a highly rewarding sector for share market investors in Australia over many years, but not so over the past twelve months. Smaller players Pact Group and Pro-Pack Packaging ((PPG)) have been among the most prominent disappointers in August with rising costs on the back of sharply higher energy prices creating a much tougher operational dynamic.
The fact the three largest companies in the sector locally have each announced one additional corporate acquisition in August should be seen against this background.
The same dynamic has started to unfold among the so-called value stocks; companies that have been under immense pressure as they were badly prepared for new technologies and changes in the competitive landscape that impacted on their market positioning and business model. This is why TPG and Vodafone Australia found common ground. This is also why Harvey Norman ((HVN)) has decided to raise $163.8m and is preparing for expansion into new geographies.
The corporate universe, and by extension the share market, is never a static proposition. The losers of the post GFC era are starting to respond, and the August reporting season has delivered plenty of examples of company boards seeking a turnaround in fortune. Other examples are the proposed "merger" between Nine Entertainment ((NEC)) and Fairfax Media ((FXJ)) and the decision to consider selling non-core assets by Coca-Cola Amatil ((CCL)).
While many of such initiatives tend to be well-received in the share market short term, investors are likely to remain sceptical about longer term viability and sustainability created by these corporate initiatives. Watch, for example, how the share price rallies in laggards such as Nine Entertainment, FlexiGroup and Telstra have had no impact on share prices of robust growing companies such as CSL, ResMed ((RMD)), Cochlear ((COH)), and others.
A similar general scepticism remains on display towards miners and energy companies. Investors are happily receiving additional benefits through surplus cash flows and capital management, but share prices remain cheap relative to most other sectors in the share market. Cost inflation proved one of the key problems for many a resources company in August.
Companies that have caught my attention during the month, include:
-Baby Bunting ((BBN)); the competitive landscape is literally disappearing, but the share market still wanted concrete evidence. The share price has now settled at a much higher level than pre-FY18 results. With analysts suggesting this could be the early beginnings of a multi-year upgrade cycle, this looks like one stock to keep a close eye on.
-Bravura Solutions ((BVS)); this service provider to the financial sector has proved to be a genuine winner since IPO-ing again in late 2016, after a period of private equity ownership. We only have Macquarie in the FNArena universe to cover the stock, but over at Wilsons the analysts are even more enthusiastic labeling the FY18 report released in August a "stand-out in the context of our coverage universe". No surprise here, Bravura remains firmly on the Wilsons Conviction List.
– Citadel Group ((CGF)); Software-as-a-service (SaaS) provider to governments, healthcare sector and tertiary education with security contracts for Defence and national security on top. Continues to win new contracts and has never come out with a big negative announcement a la Integrated Research or Hansen Technologies. Double digit growth looks secured for the years (multiple) ahead and all three of Shaw and Partners, Bell Potter and Wilsons seem convinced the risk remains to the upside.
-Freedom Foods Group ((FNP)); nobody would call this stock "cheap" trading on a forward PE multiple in excess of 50x, but then past investments are paying off through higher margins and accelerating profit growth with Citi analysts predicting earnings per share can potentially more than double over the next two years. No guessing as to why the analysts think this is one of the most exciting stocks under their coverage in Australia.
-Goodman Group ((GMG)); the All-Weather Model Portfolio was forced to sell its share in Goodman Group in mid-2016 as it became apparent fellow investors were not going to take any prisoners and sell down everything with even a hint of bond market correlation. Sadly, we never revisited the investment case while the shares were beaten down, and we have been regretting it every day since. Regrets, we all have a few. This is such a strong management team, operating one of the most robust and high quality growth companies in the local property/bond proxies segment. August saw management upping guidance for the years ahead. Consider this one Royalty with leverage to online retail sales.
-Wesfarmers ((WES)); Hope springs eternally and we only have to look at the Wesfarmers share price since April this year to witness that statement in live view. But Wesfarmers probably delivered one of the stand-out financial performances among large cap companies in Australia, which is why broker price targets made a decisive jump higher, but also why the share price remains at a sizable premium. Bunnings is slowing though and Coles will soon operate under its own stand-alone management (with too high a dividend burden). What is the future going to look like? Seldom has this question been as fitting as for the conglomerate from West Australia. I doubt anyone knows the answer.
All of the above in addition to the stocks included in the All-Weather Model Portfolio, of course, as well as those listed on the dedicated page of the FNArena website (exclusively available to paying subscribers, 6 and 12 months). I believe one of the stand-out characteristics of the August reporting season is how investors have continued to show their preference for robust growth stories (like CSL) and their willingness to forgive small misses and minor negatives, such as has been the case for ResMed, Cochlear, and others.
https://www.fnarena.com/index.php/2018/08/08/august-reporting-season-preview-potential-beats-misses/ (week before week prior)
FNArena maintains a Corporate Results Monitor on its website: https://www.fnarena.com/index.php/reporting_season/
September Index Changes
Three weeks ago I wrote about the next round of local share market index changes to be announced by Standard&Poor's coming Friday, September 7th and what analysts at Wilsons predicted what might happen.
Their peers at Morgan Stanley have a slightly different set of forecasts, anticipating no changes to either ASX20 or ASX50. Any changes here come with very little consequences, if any, but that is not necessarily the case for any of the larger indices.
Morgan Stanley sticks with the forecast TPG Telecom ((TPM)) is likely to lose its spot inside the ASX100, even with a pending merger on the cards with Vodafone Hutchison Australia, which also affects index orphan Hutchison Telecommunications Australia ((HTA)).
Morgan Stanley observes the proposed shareholder structure still implies a merged entity TPG/VHA is likely to fall short of free-float requirement. A second candidate for index demotion is struggling value-investor, Perpetual ((PPT)).
The two prime candidates to replace TPG and Perpetual are, according to Morgan Stanley's data analysis, Reliance Worldwide ((RWC)) and WorleyParsons ((WOR)). The general risk is that small cap investment funds might be forced to sell out while there is no need for their large cap peers to get on board in a hurry.
Consequences for inclusion/exclusion in the ASX200 are usually larger, and more sustainable. Morgan Stanley nominates freshly listed Viva Energy Group ((VEA)) and Bingo Industries ((BIN)) as most likely new inclusions replacing Genworth Mortgage Insurance Australia ((GMA)) and Greencross ((GXL)), respectively.
Also considered a potential new ASX200 inclusion, but with less probability, are Elders ((ELD)), Kidman Resources ((KDR)) and Emeco Holdings ((EHL)) in which case IPH ltd ((IPH)), Australian Pharmaceutical Industries ((API)) and Infigen Energy ((IFN)) are considered most likely to be dropped.
Just to recap my story from two weeks ago, Wilsons analysts suggested Brambles ((BXB)) membership of the ASX20 could be under threat in favour of Aristocrat Leisure ((ALL)). Wilsons made the same suggestions as far as the ASX100 is concerned (swap TPG and Perpetual for Reliance Worldwide and WorleyParsons).
For the ASX200, Wilsons has lined up Viva Energy Group ((VEA)), Elders ((ELD)), Emeco Holdings ((EHL)) and Bingo Industries ((BIN)) as most likely new inclusions while those most at risk for losing their current spot include Genworth Mortgage Insurance Australia, Greencross and Australian Pharmaceutical Industries.
As always, most changes are likely reserved for the ASX300 where Beadell Resources ((BDR)), Retail Food Group ((RFG)), iSelect ((ISU)), Sky Network TV ((SKT)), iSentia ((ISD)), Ainsworth Gaming ((AGI)), ImpediMed ((IPD)) and Mortgage Choice ((MOC)) are believed to be at risk, but possibly also Magnis Resources ((MNS)), Amaysim ((AYS)), Servcorp ((SRV)) and Class ((CL1)).
Candidates lining up to be included in the ASX300 are Pinnacle Investment ((PNI)), Clinuvel Pharmaceuticals ((CUV)), OM Holdings ((OMH)), Jupiter Mines ((JMS)), Sundance Energy ((SEA)), Nearmap ((NEA)) and Megaport ((MP1)) while Wilsons also believes Viva Energy Group, New Hope Corp ((NHC)), Praemium ((PPS)), Aurelia Metals ((AMI)), Wagners Holding ((WGN)), Polynovo ((PNV)) and Integral Diagnostics ((IDX)) stand a chance for ASX300 index inclusion as well.
All shall be revealed on Friday.
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Monday, 7.30-8pm, Money Talks with Peter Switzer
-Tuesday, 11.15am Skype-link to discuss broker calls
-Friday, 11.15am, 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
-AIA Celebrity Lunch, Brisbane, on November 3
(This story was written on Monday 3rd September 2018. It 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).
(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: firstname.lastname@example.org or via the direct messaging system on the website).
BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS
Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:
– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.
Subscriptions cost $420 (incl GST) for twelve months or $235 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup
(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.)