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February 2019 Result Season: The Wrap

Feature Stories | Mar 06 2019

Download related file: FNArena-Reporting-Season-Monitor-Feb-2019

By many metrics, the result season now past was one of the worst on record.

-Blowout in forecast "misses"
-Downgrades far exceed upgrades
-Don't mention the housing crisis

By Greg Peel

With the February result season now complete in 2019, the FNArena Corporate Result Monitor, which has been building throughout the month, is now complete and published in its final form (see attachment).

The table contains ratings and consensus target price changes along with brief summaries of the collective responses from FNArena database brokers for each individual corporate result, and an assessment of “beats” and “misses”.

Australian corporate results tend to focus on the profit line, with all its inherent potential for accounting vagaries, tax changes, asset write-downs and other “one-off” impacts.

FNArena has focused mostly on underlying earnings results (more in line with Wall Street practice) as a more valuable indicator of whether or not a company has outperformed or underperformed broker expectations. There is also a level of “quality” assessment here rather than simple blind “quantity”.

The Monitor summarises results from 308 major listed companies. By FNArena’s assessment, 102 companies beat expectations and 103 missed expectations, for a percentage ratio of 33/33 or 1.0 beats to misses. The simple average of all resultant target price changes came in at a net -0.1% reduction. In response to results, brokers made 31 ratings upgrades and 93 ratings downgrades, or a ratio of 3 to 1 downgrades to upgrades.

The first FNArena Corporate Result Monitor was published in the August season of 2013. See table:

Poor Season

The ratio of beats, meets and misses of consensus forecasts this season came in at a third/a third/a third. One might be forgiven for assuming that when over 300 reports are being assessed by up to eight brokers in some cases, the Law of Averages would start to apply such that a third/a third/a third would be exactly the outcome simple regression would suggest. But this is far from the case.

It is a truth universally acknowledged that a CEO must be in want of a positive share price reaction to a result release. The “stairs and elevators” principle applies to stock market movements in general but at reporting season time, this principle is amplified. Most “beats” are met with modest share price improvement on the day. Most “misses” are met with a trouncing. To that end CEOs tend to provide what is commonly referred to as “conservative” earnings guidance. This provides a better chance of a “beat” at the end of the period.

Which is why the average beat to miss ratio on the table above is 31.7% to 24.5% and not 33/33.

It must also be noted that while profit warnings are frequent ahead of any results season, profit upgrades in the lead-up are rare. Typically, companies like to get the bad news out as soon as possible to temper the trashing they would receive if a big miss came as a shock. On the other hand, nobody minds a big beat. What the “miss” count does not show is how many companies reported “in line” with estimates that had earlier been downgraded following a profit warning.

Ahead of this season, there were a lot of profit warnings issued. Some as late as a week before scheduled report release, and many of them were very bad. Take Bingo Industries for example – down -49% on a profit warning just a week before result release.

As it happened, Bingo’s result still went down as a “miss” on the Monitor because despite the warning, the numbers still managed to disappoint. But there are a lot of companies who posted “in line” with lowered guidance, meaning we can argue the “miss” count should actually be greater.

Yet still the “miss” count this season is the worst on record, by a margin. It is not the first time “beats” have failed to outpace “misses” – we saw that in August 2017 — but at 33%, this season’s “miss” count well exceeds an average of 24.5%. The highest previous number was indeed in August ’17, but that was only 27%.

It should be noted that 33% “beats” is at the better end of the historical scale, above the average of 31.7%, but also that an “in line” count of 33% is well below an average of 44%. Do we put that down to poor forecasting from analysts? Or simply to the shock of so many misses?

It is also notable that for the first time on record, the average of all target prices actually receded. Only by -0.1%, but this is against an average of +2.7%. Again, on this metric, we can call this season a bit of a shocker.

One might be forgiven for assuming a flat target price move suggests simply that the analysts got it right, but that is not the case.

One reason for this is what brokers call “valuation rollover”. While different valuation models are applied to different sectors and stocks, the discounted cash flow (DCF) model is the most prevalent. This model basically discounts a broker’s earnings forecasts “over the forecast period” (typically five years) by the prevailing real interest rate.

When a company reports its result, all outer year forecasts then shuffle forward and a new period is added. Inflation ensures the nominal value of money simply rises over time. Thus ceteris paribus, we will always expect the average target price to rise.

But not this February.

What was notable this February was a strong rally for the ASX200 over the month of the result season, of 5.2%. This upside move is the second largest on record. And when we consider the index actually rallied 7% from Christmas to the beginning of the season, results were being reported before a positive macro backdrop of central bank relief, global trade hopes, strong commodity prices and a bit of help from the Hayne Train.

One wonders how investors might have responded to record misses if the index was in a downward trend at the time. The rally could, nevertheless, provide the reason why the average target price increase was not an increase at all. It also explains to some extent why the number of ratings downgrades from brokers in response to results exceeded upgrades by 3 to 1.

We can roughly divide ratings downgrades into two types – “bad” and “too good”. If a downgrade is the result of a broker’s view souring in response to a result, that’s “bad”. But if a broker downgrades simply because the share price had already run up too far ahead of the release, or too far on the day of the release, we can call that “too good” , which is a lot different to “bad”.

The average of broker upgrades to downgrades is -0.9, meaning slightly leaning towards more downgrades but close enough to one to one. Comparing each season’s ratio to the index move over the period reveals, unsurprisingly, that downgrades tend to exceed upgrades in up-markets and vice versa in down-markets. The ratio of downgrades to upgrades this season is the second highest on record, beaten only by February ’15, which also produced the biggest index rally on record.

Thus while this season counts as “poor” on many metrics, we can’t take the excess of downgrades as being further evidence as the bulk were likely value calls – “too good”.

Dark Cloud

If there were one specific theme dominating this season’s analysis of results and guidance by brokers, it was the housing slowdown. It was remarkable to read time and time again of housing being front and centre of updated analyst forecasts in almost every sector and sub-sector of the economy.

Some sector impacts are obvious – property developers and building material suppliers are clearly on the front line – but when we consider the impact of the psychological “negative wealth effect” of falling house prices, and thus reduced perceived wealth, then it’s like the Grim Reaper has come to knock on almost every door.

Consumer discretionary cops the brunt. Particularly big ticket items such as cars, furniture and electronics, but really anything reliant on consumer spending. This then feeds into retail REITs as well.

The banks are impacted (lower mortgage demand, rising defaults). Healthcare is impacted (might have to put off the heart transplant until house prices recover). Residential aged care is impacted (a house by any other name). The list goes on and on.

Updated forecasts from analysts in the wake of individual results, and subsequent Buy, Hold or Sell ratings, in so many cases now reflect a simple disparity among those fearing the housing slowdown is going to be really bad and those who don’t agree, or at the very least believe the company in question can weather the storm.

Rolling in it

While we could take the housing slowdown impact argument all the way to the iron ore and coal that make the steel that builds buildings, the other standout feature of this season was the abundance of free cash flow enjoyed by mining companies, mainly the biggies, and how much of that was handed out as a thank you to shareholders. More than was forecasts in most cases.

While this is all well and good for those shareholders, there is a dark side to special dividends, increased payout ratios and share buybacks. They imply boards have no idea what else to do with the money and thus are bereft of growth opportunities. This does not bode well for the future. Although it must be noted that some resource companies have so much cash they can offer hand-outs while still funding growth projects.

The tragedy in Brazil will likely ensure the price of iron ore will remain elevated for some time. As for other commodities, the outlook is not so clear. Beware the global slowdown.

As we put this season to bed the market is waiting with baited breath to whether the US and China can indeed reach an agreement on trade, whether Britain is headed to hell on a hand cart or not, and whether the likes of Germany and Japan are set to slide into recession.

Locally, whether the housing slowdown will ultimately force the RBA to cut.

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