Rudi’s Comprehensive Feb 2019 Review

Feature Stories | Mar 26 2019

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

The story below is a compilation of stories relating to the February 2019 corporate reporting season in Australia, published between late January and early March. Attached is FNArena's final balance for the season.

Content:

-February Reporting Season Preview
-February Previews: Miners & Energy
-February Reports: Early Resilience & Big Disappointments
-February Reports: Is Not As Bad Good?
-Reporting Season: Reality Versus Sentiment
-February Reporting Season: Final Observations

By Rudi Filapek-Vandyck, Editor

February Reporting Season Preview

The public debate as to whether the US, and by extension the global economy, is heading for a recession has quickly fallen flat in early 2019. Very little works as reassuringly as rising share prices, and as the dire and gloomy final quarter of calendar 2018 has been followed up by one of the strongest January performances on record, investors worldwide seem to accept that maybe there still is a valid alternative in between raging bull and relentless bear.

One might be inclined to draw a parallel with early 2016. Things seemed similarly doomy and gloomy at that time, but the Federal Reserve, then chaired by Janet Yellen, got the message and pressed the pause button. By year's end the outcome for global equity markets turned out a lot better than many would have dared to predict at the start of the year.

I doubt whether 2019 will carbon copy the year 2016, though we do share Brexit on the calendar, and the RBA is patiently sitting on its hands. Global growth appears to be decelerating rapidly, with growing concerns about Europe and China, while indicators and data in Australia further highlight all is not well with construction of apartments and consumer spending.

For the local share market specifically this implies earnings forecasts and short-term valuations will need to reset at a lower level; a process that has already started ahead of the February reporting season. Analysts at stockbrokerages have been busy cutting estimates and price targets for a number of weeks. But many a share price is by now trading at a level well below last year's peak in August.

The Big Question for investors then becomes whether forecasts still need to be reduced further or whether share prices are already reflecting an outlook too dire for what likely awaits next?

The proof of the pudding, as the old saying goes, is in the eating. Corporate results, and in particular forward guidance provided over the following 3-4 weeks, will be submitted to extreme scrutiny, if only because many investment portfolios got dented, battered and bruised throughout the late 2018 turmoil, and investors will be anxious to avoid further disappointment.

Properly assessing this "earnings recession" is now on every investor's mind. Is it really as bad as (some) share prices are suggesting? Where are the likely surprises? How much risk is there still out there? Is it really worth trying to go contrarian?

Corporate reporting seasons overseas are only half-way through at the most, but observations to date suggest the US looks reasonably OK, while Europe has been rather disappointing. And Australia? Locally we don't have much to work with yet, apart from a few dozen negative profit warnings, mostly from small cap companies, plus a handful of early corporate result releases.

The February reporting season is still only warming up. The calendar gets busier next week, but in particular in the final two weeks of the month. Meanwhile, local investors have enjoyed higher share prices in response to a much more relaxed Federal Reserve, and on expectations of no escalation in tensions between the Trump administration and China; OK corporate results in the US have further supported general sentiment, as did the final Hayne report following the Royal Commission into banks and financial service providers.

Post its February Board meeting on Tuesday, the RBA's assessment included a downgrade of the economic outlook while highlighting additional downside risks, while still maintaining a positive outlook overall.

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In terms of concrete signals from the corporate coal face, more than twenty profit warnings issued by small cap companies throughout December have been followed up in January with similar warnings from the likes of Investsmart Group ((INV)), Yowie ltd ((YOW)), Wagners Holding Co ((WGN)), McPhersons ((MCP)), Oliver's Real Foods ((OLI)), and Navigator Global Investments ((NGI)) in further evidence operational momentum late last year has run into a serious slow-down headwind for a number of Australian companies, in line with economic data and indicators.

The impact from the global slow-down is not restricted to small caps, as shown by recent profit warnings issued by Sims Metal Management ((SGM)), Boral ((BLD)), Costa Group ((CGC)), Platinum Asset Management ((PTM)), Kathmandu ((KMD)), and several others.

As far as actual corporate results are concerned, ResMed ((RMD)) and GUD Holdings ((GUD)) both missed market expectations and their share prices were sold down in response, quite savagely too with ResMed's US-listed shares losing in excess of -20% immediately after the quarterly update. Both are quality, resilient performers with a positive track record, and a longer-term growth path intact, which is probably why their share prices have somewhat recovered since.

The treatment of both "misses" however will have put experienced investors on notice: things can get quite brutal if corporate results somehow miss the mark. Fund managers will have responded by taking some share market exposure off the table, with the aim of slightly reducing risk and having the ability to respond to outbursts in short-term volatility.

Credit Corp ((CCP)) did perform better than expected, but forecasts and broker price targets didn't move that much higher, so the initial jubilation was quickly met by traders selling. That is the other kind of risk this month: maybe most of the good news is already in the share price?

The other scenario is, of course, a share price that is simply too low for whatever seems to be happening operationally. Here, investors can take heart from the market's response following an update by perennial disappointer James Hardie ((JHX)). While the quarterly performance continues to look subdued, management has announced a new cost reduction program and narrowed guidance for the full financial year. The share price jumped by 6%-plus on Tuesday.

Admittedly, the stock lost a big chunk of its value since August last year -some -37% on the back of two consecutive disappointing market updates- but the underlying message is nevertheless that some share prices at least have fallen too deeply.

Combine all of the above, and the February reporting season will inevitably become the first major litmus test for how corporate Australia is coping with the many headwinds and challenges. We can all believe, suspect, speculate and predict, but ultimately the financial numbers and their impact on market forecasts and sentiment will do the main talking.

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Every reporting season has investors and analysts worried about at least one segment of the market and this time around the widespread concern is about the general deterioration in consumer spending, which is expected to weigh upon financial performances of discretionary retailers and automobile-related business models. But not all of them, of course, and not all of them to the same degree.

Carsales' ((CAR)) share price has fallen quite dramatically since September last year, but many a sector analyst thinks the resilience of its core business, which revolves around selling and buying of second hand cars, should shine through this month. Automotive Holdings ((AHG)), on the other hand, is often mentioned as more likely to issue yet another disappointment, as is Motorcycle Holdings ((MTO)).

A similar divergence could open up between bricks and mortar retailers with some analysts speculating share prices for the likes of Super Retail ((SUL)), JB Hi-Fi ((JBH)), and Harvey Norman ((HNV)) could actually rally in the absence of any further negatives. But given they also think this theme is going to stick around for longer, questions are being asked about realistic prospects and sustainability of any share price gains further out.

On the flipside, Baby Bunting ((BBN)) and Accent Group ((AX1)) are expected to come out with strong results, possibly even better than what is expected. Opinions remain divided about what to expect from cheap bling jeweller Lovisa Holdings ((LOV)), as well as from ARB Corp ((ARB)) and Bapcor ((BAP)) with some analysts suggesting the latter company might surprise with a better-than-expected guidance. Either way, all analysts remain convinced Bapcor remains a solid longer term growth story.

But more so than on the retailers, investors' attention is increasingly directed towards listed landlords for those retailers in the form of shopping mall owners, in particular those who own and operate sub-regional and neighbourhood malls (as opposed to prestigious inner-city towers). One team of sector analysts at Deutsche Bank has gone as far as to declare 2019 to be the turning point for retail assets, in a negative way.

Retail assets in recent months have been bought and sold at small discounts to book value (between -2-5%) and Vicinity Centres ((VCX)) already incorporated a minor write down for the value of its assets. These signals are minor in itself, but nothing in this sector moves rapidly and it is hard to argue that if this is now the new trend, share prices will find it hard to move much higher irrespective of present Net Tangible Value (NTA) calculations.

Irrespective, some analysts still argue the market is being too harsh on Stockland ((SGP)) and Mirvac ((MGR)), while Viva Energy REIT ((VVR)) is also mentioned for possibly releasing a strong report. The same applies for Goodman Group ((GMG)) and Charter Hall ((CHC)), as industry dynamics for industrial property remain strong, but here lofty valuations are oft mentioned as a major impediment to get more excited.

The downturn for housing construction is expected to linger for longer, and this, obviously, is weighing upon prospects and valuations for building materials stocks. BlueScope Steel ((BSL)) too might be starting to feel the pinch. James Hardie ((JHX)) was widely predicted to release yet another disappointing quarterly performance. These expectations proved accurate but management's promise to reduce costs by a further $100m had investors excited, and thus the share price responded positively.

Resources in a broad sense seem cum upgrades because commodity prices are mostly higher than forecasts, but, as per always, divergences are wide and widespread, and many doubt whether it can last. Miners are the only sector that has enjoyed upgrades to forecasts pre-February reporting season.

In a general, broad market sense, earnings estimates have fallen from a forecast of 6%-plus on average in late 2018 to now circa 4%, which is below the two prior years as well as below historical trend in Australia. However, most analysts and strategists remain of the belief this average will be even lower by the beginning of March. Ex-resources and ex-banks the average forecast EPS growth now sits at 1% only, suggesting this number is about to fall into negative territory.

No guessing why most analysts are expecting February will see more surprises to the downside than to the upside.

Financials will not be the sector to turn this trend around. At least not in the short term. Commonwealth Bank ((CBA)) had been predicted by many an analyst to likely fall short of already subdued expectations, and CBA's report did exactly that on Wednesday. Overall enthusiasm for Bendigo and Adelaide Bank ((BEN)) is even lower.

Diversified financials, predominantly asset managers and insurers, might have a negative skew because of last year's heavy turmoil across financial markets globally. Funds managers are battling underperformance, downward pressure on fees and funds outflows, while insurers are expected to release quite messy results, including weather-related claims, restructurings and asset sales. Analysts weren't quite sure what to expect from Insurance Australia Group ((IAG)) either, but the jump in share price following the release of H1 results suggests investors are willing to look through minor negatives and instead concentrate on the positives.

Here one observation stands out: while uncertainty still reigns about what exactly will the February result release look like for Link Administration ((LNK)), given local superannuation industry changes and Brexit in the UK, virtually every sector analyst has this company as the top favourite, if only because the share price is deemed too cheap.

Elsewhere the team at Citi is worried growth in dividends for infrastructure stocks Sydney Airport ((SYD)), Transurban ((TCL)) and Auckland International Airport ((AIA)) might be cum de-rating. The analysts will be extra attentive, looking for further evidence this reporting season. In media, Nine Entertainment ((NEC)) is considered a prime candidate for releasing a solid performance, while Domain Holdings' ((DHG)) share price has already come under pressure in anticipation of a rather weak financial report.

As far as individual companies are concerned, UBS sees dark clouds approaching for A2B Australia ((A2B)) (formerly Cabcharge), Automotive Holdings, Netwealth ((NWL)) and Servcorp ((SRV)) but potentially better results and better guidance from companies including Adairs ((ADH)), Appen ((APX)), Corporate Travel ((CTD)), Cleanaway Waste Management ((CWY)), G8 Education ((GEM)), Infomedia ((IFM)), Imdex ((IMD)) and Webjet ((WEB)).

Out of this selection, both G8 Education and Webjet are currently dividing opinions with analysts elsewhere either agreeing or disagreeing.

UBS also believes companies including AMA Group ((AMA)), Bapcor, Costa Group, Freelancer ((FLN)), Kogan ((KGN)), Megaport ((MP1)) and NRW Holdings ((NWH)) are likely to surprise through positive guidance.

Morgan Stanley continues to like offshore earners with IDP Education ((IEL)), Nearmap ((NEA)) and MNF Group ((MNF)) upheld as "compelling structural growth" stories, alongside Baby Bunting and McMillan Shakespeare ((MMS)). Stocks to avoid, according to Morgan Stanley, include Webjet (!), InvoCare ((IVC)), Lovisa (!), 3P Learning ((3PL)), SG Fleet ((SGF)) and Automotive Holdings.

Stockbroker Morgans is counting on Treasury Wine Estates ((TWE)), Jumbo Interactive ((JIN)), Acrow ((ACF)), Corporate Travel, Medibank Private ((MPL)), and Baby Bunting to deliver positive surprises. Capital management initiatives could be forthcoming from the likes of Woolworths ((WOW)), Wesfarmers ((WES)), ERM Power ((EPW)), Flight Centre ((FLT)), and Whitehaven Coal ((WHC)).

Morgans also lists a number of candidates it believes only have to meet market expectations to see their share prices rally: Reliance Worldwide ((RWC)), Kina Securities ((KSL)), Origin Energy ((ORG)), Emeco Holdings ((EHL)), Coronado Global ((CRN)), Apollo Tourism ((ATL)), Monash IVF ((MVF)), and Adairs.

Companies poised for a "miss", according to Morgans, include Sydney Airport, Superloop ((SLC)), Pact Group ((PGH)), InvoCare, Ansell ((ANN)), Ramsay Health Care ((RHC)), JB Hi-Fi, National Tyre & Wheel ((NTD)), Motorcycle Holdings, Bapcor (!), and Automotive Holdings.

Stocks to avoid include Speedcast International ((SDA)), Blackmores ((BKL)), Bellamy's ((BAL)), and Inghams Group ((ING)).

Analysts at Wilsons see positive surprises coming from Austin Engineering ((ANG)), Ausdrill ((ASL)), Alliance Aviation ((AQZ)), Bravura Solutions ((BVS)), Countplus ((CUP)), EML Payments ((EML)), EQT Holdings ((EQT)), Nick Scali ((NCK)), Noni B ((NBL)), National Veterinary Care ((NVL)), and NRW Holdings.

Candidates for downside surprises not yet anticipated or priced in are Ainsworth Gaming ((AGI)), ARB Corp, Class ((CL1)), G8 Education, Mayne Pharma ((MYX)), Motorcycle Holdings, and Silver Chef ((SIV)).

Last but not least, some analysts are speculating resurrected (sort of) Telstra ((TLS)) might deliver yet another bombshell in flagging another reduction in shareholders' dividend. Local superstar CSL ((CSL)) is expected to put in yet another solid financial performance, without an upgrade to guidance. The question then remains: is the short term money possibly expecting more?

For investors it is good to keep in mind all of the above are best guesses and forecasts, and investor responses don't always seem straightforward and logical, at least not in the short term when speculation, market positioning and macro-considerations can have their say as well. Short term disappointment does not by default translate into long term underperformance, though impacts can linger for three months and longer. All shall be revealed over the next three weeks, hopefully.

February Previews: Miners & Energy

Commodity prices have remained persistently high, but costs have been rising too and resources analysts at UBS, for one, believe one factor will be found to have largely cancelled out the other factor throughout the February reporting season in Australia.

UBS analysts see their confidence in both dynamics growing having paid attention to what companies have been communicating and reporting in overseas markets. If the offshore pattern is to be repeated here in Australia, companies exposed to aluminium in particular might be prone to disappointment because of higher-than-forecast costs.

Nevertheless, conservative balance sheets are still offering further room for capital management, including sizable cash returns to shareholders. UBS has nominated Rio Tinto ((RIO)) as primes inter pares when it comes to having the ability to return cash -lots of it- to eager shareholders.

Numerous asset sales plus healthy operational margins on the back of a higher-for-longer iron ore price may well translate into the Rio Tinto board expanding the current share buyback to US$3.6bn, while also announcing a special dividend in excess of US$1bn, while still paying out a large ordinary dividend. There's no end to the cash boom times this time around!

More cash back surprises could stem from Alumina ltd ((AWC)) and from ex-BHP's South32 ((S32)), with gold miner Evolution Mining ((EVN)) potentially joining the sector's cash splash later in the year. Newcrest Mining ((NCM)) could also join in, but the board at Australia's largest gold miner needs to keep an eye on capex requirements for Golpu, UBS explains.

Macquarie, on the other hand, predicts investors will have a harder-than-usual task in assessing financial performances from oil and gas producers this season, and accountancy adjustments and forthcoming changes to the petroleum resource rent tax (PRRT) are to blame.

First off, the introduction of AASB16 as of January 1st this calendar year affects the way leasing arrangements are being accounted for, now turning into financing costs from depreciated assets and liabilities previously. It sounds complicated, and it probably is too much detail already for many of us, but the change in accountancy will disturb analysts' neatly kept excel file data in a meaningful way, says Macquarie.

The Coalition government has already expressed the intention of moving into a new PRRT regime by July 1, 2019.

Macquarie thinks Woodside Petroleum ((WPL)) stands to be most affected by both impacts, and is therefore preaching caution ahead of its financial result this month. Santos ((STO)) remains the broker's top pick, also because cost cutting, drilling and acquiring the Quadrant asset all seem to have gone smoothly thus far, virtually guaranteeing positive karma and share price momentum.

All of the above should bode well for engineers, contractors and whoever provides services to resources companies. It therefore cannot be a surprise that analysts are anticipating some stellar results from this particular segment this month. Wilsons' three sector favourites are Ausdrill ((ASL)), Austin Engineering ((ANG)), and NRW Holdings ((NWH)).

Two other Buy-rated sector peers are Monadelphous ((MND)) and Mastermyne ((MYE)). Analysts at Wilsons are expecting guidance to be at least maintained across the sector, if not supported by signals the outlook overall for these services providers is steadily improving.

Macquarie likes Beach Energy ((BPT)) as well.

Energy companies across the board are expected to start talking up their growth aspirations by 2025, predict the analysts, pointing out this in itself will mark a major shift from recent years when stabilisation was the sector's prime focus.

February Reports: Early Resilience & Big Disappointments

Late in January, I had an inkling we might be staring at an unusually savage reporting season locally throughout February.

My concern stemmed from the way investors had responded to early "misses" from the likes of ResMed ((RMD)) and GUD Holdings ((GUD)); it was immediate, harsh and merciless.

Every reporting season generates winners and losers, based upon "beats" and "misses" derived from corporate financials, but this time around share markets have gone through a wild rollercoaster ride, economic data are weak, and weakening, central bankers are reviewing their policy stance, and profit forecasts have been steadily sliding downwards for months.

Judging from the first 100-odd companies in the FNArena universe having reported their financial numbers thus far this month, it would appear the news to date is less bad than feared, if we measure total "beats" versus "misses" or we concentrate on the fact most companies have stuck by a relatively optimistic guidance for the full year.

But market forecasts ex-resources are still steadily sliding south and, on my observation, many companies that release financial reports experience downward pressure on the share price. If not on day one, then most likely in the days following the results release. Surely many an investor -both professionals and retail- has been wondering just how hard it is to successfully maneuver the ins and outs of February this year?

In terms of stockbroker ratings, the bias is very much weighted towards downgrades in recommendations. Total downgrades for the season thus far stand at 44 versus 14 upgrades, and these do not include many more that are not directly related to financial results released.

On Tuesday, when I write these sentences, total tally for the day is seven downgrades against one upgrade to Hold (!). At least on Monday, the balance was three against three (this is an exception though).

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As far as "winners" are concerned, companies including Magellan Financial ((MFG)), IDP Education ((IEL)), Cleanaway Waste Management ((CWY)), Goodman Group ((GMG)), Breville Group ((BRG)), and Altium ((ALU)) have proven that, this time around, they are not impacted by weak conditions and shaky confidence, instead showing off internal resilience and strong growth numbers, leaving both analysts and shorters scrambling to catch up post result.

Each of these companies will feature prominently on the short list of quality positive surprises at the end of the season.

On the other end, the list of negative surprises is already quite a long one, and growing by the day. Today, Tuesday 19 February, share prices for Blackmores ((BKL)) and Emeco Holdings ((EHL)) are both down in excess of -20%. Yesterday, a profit warning from Bingo Industries ((BIN)) caused that share price to fall by -49%.

Investors have equally not been kind to regional lenders Bendigo and Adelaide Bank ((BEN)) and Bank of Queensland ((BOQ)); the latter issued a trading update, Helloworld ((HLO)), Smartgroup Corp ((SIQ)), Bapcor ((BAP)), Automotive Holdings ((AHG)), Carsales ((CAR)), Challenger ((CGF)), Praemium ((PPS)), and numerous others.

While Healius ((HLS)) proved you can put a different name on a perennially disappointing business, but the underlying operations will still keep issuing profit warnings. Pact Group ((PGH)), can you imagine, has issued its sixth profit warning since May 2017, its second over the past three months.

One pleasant surprise is some retailers are managing to withstand general scepticism, releasing relatively resilient numbers accompanied by cautiously optimistic outlooks; think JB Hi-Fi ((JBH)), Nick Scali ((NCK)), and City Chic Collective ((CCX)). The real question here remains, of course, is it sustainable? What if consumers further tighten their belts? Can online competition be held at bay indefinitely?

Both results from Unibail-Rodamco-Westfield ((URW)) and Vicinity Centres ((VCX)) revealed risks are rising for retail landlords. Equally important: investors bamboozled by an apparent easy yield on offer, but no growth, beware.

Companies including Medibank Private ((MPL)), Computershare ((CPU)) and Insurance Australia Group ((IAG)) have equally shown resilience, but their path forward remains too clouded for many.

As mentioned, early disappointments have come out in spades. They include high quality, long-term sustainable growth companies, and popular market darlings REA Group ((REA)), Carsales, Bapcor, ResMed, Cochlear ((COH)), Transurban ((TCL)), possibly even CSL ((CSL)) – see also further below.

For many of these consistent (out)performers, the pattern from past reporting seasons often means share prices respond negatively to results releases, but they pick up later when the market's attention shifts from short term disappointment to longer term fundamentals. Observe, for example, how shares in REA Group are by now well ahead of where they were prior to the interim report release, despite management issuing rather sober guidance for H2.

Irrespective, market sentiment can be fickle and not always as predictable as history suggests. I for one will be watching these share prices from close distance, also because they still make up the core of the FNArena/Vested Equities All-Weather Model Portfolio.

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Combining all of the above, analysts at CommSec have calculated profit growth for ASX200 members that have reported to date averages 7%, which is far from bad, but the average EPS growth would be less as companies pay for acquisitions through issuing extra shares.

CommSec has also calculated average growth in operational costs for these companies is above 9%, which provides a firm indication about one of the key problems that is surfacing this reporting season: companies might still be selling more products and services, but their costs are rising fast.

Rising costs are equally a problem for resources companies, Whitehaven Coal ((WHC)) comes to mind, but at least miners and energy producers are enjoying an upward boost to forecasts because of higher-for-longer prices for their product. Looking into the details thus far, this seems to apply more for miners than for oil and gas producers, at least thus far.

Financials, including banks, are not doing so well. Among industrials, traditional media companies stand out in a negative way, as also illustrated by the profit warning of Seven West Media ((SWM)) on Tuesday.

Deutsche Bank strategists, who have been mildly positively surprised by reporting season thus far, report only about half (50%) of companies reporting have triggered a downgrade in estimates post report against an average of 56% for past reporting seasons.

Citi strategists who had earlier suggested the average growth forecast for the Australian market ex-resources and ex-banks might end in the negative by month's end (from an underlying EPS growth forecast of circa 1.5%), are now suggesting that number could possibly remain above zero.

The average EPS growth forecast for banks has now fallen to only 1% for FY19. For resources companies the growth forecast has increased to an average 13.5%, to be followed by 2% growth for FY20 (but this far out such forecasts are very "rubbery").

For the share market ex-banks and ex-resources the average EPS growth forecast has now shrunk to 1.3% from 1.5% before February. But let's face it, it's early days still, and history suggests the real bad news more often than not hides inside the tail end of the season.

Maybe not this time around. Citi strategists, for one, are growing more optimistic. They have retained their forecast for the ASX200 to end the calendar year at around 6300.

February Reports: Is Not As Bad Good?

One of the key events this reporting season occurred on the final day of the opening week, Friday the 8th of February. Local real estate platform REA Group ((REA)) alongside parent News Corp released interim financials, and while the operational numbers looked robust and resilient, management's guidance for a more subdued, elections impacted second half period was instantly interpreted as an invitation to sell down the stock.

Flash forward two weeks, and today the share price sits well above the levels both prior to and after the release of interim financials.

This is not standard practice. Usually, and I am leaning on experience from many years of observing and analysing corporate reporting seasons in Australia, following a disappointing market update, and subsequent public flogging, share prices of stocks such as REA Group remain in the doghouse for a while longer.

In a world that is increasingly short-term focused, all investors need to know during and immediately after reporting season, apparently, is whether the result beat expectations, or whether it was a disappointment. In case of the latter, investor interest may well remain lukewarm for a number of months, depending on the magnitude of it all, and whether there are ample opportunities available elsewhere.

In REA's case, history shows that when the company disappointed in August 2016, the share price didn't bottom out until the calendar read November, after which the prior uptrend in the share price resumed. By April the following year -eight months after the results related sell-down- REA's share price was back at pre-August release levels, and continued trending higher.

This time around the immediate "loss" suffered by loyal shareholders (such as myself) only lasted for about one week, give or take. And REA Group shares are far from the only ones to swiftly recover from earnings update inspired weakness. Take a look at Carsales ((CAR)) -same pattern- or Link Administration ((LNK)) -again, same pattern. Idem for GUD Holdings ((GUD)).

In contrast, when Insurance Australia Group ((IAG)) updated on the 6th of February, the release was labelled a "beat" by all and sundry, and the share price rallied on the day. But there never was any follow-through. In the three weeks post the IAG market update the share price has bit by bit given up on the share price gains booked on the day of release, to ultimately end up lower than on the days prior to the market update.

So who are the real winners and losers in this February reporting season? The distinction between the two has, according to my memory, never been this blurred.

Reporting season in February still has a few more days to run, but already it has become clear total "beats" and total "misses" are in a tight contest to grab the largest percentage of the season's corporate reports. FNArena has been closely monitoring local reporting seasons since August 2013, but never have we witnessed such a tight race between "beats" and "misses", i.e. between "positive surprises" and "negative disappointments".

Underlying, earnings estimates are trending south, outside resources, but probably at a slower pace than predicted pre-February. Valuations and price targets are struggling to stay positive, for the season as a whole. If the end result ends up negative, this too will be a first since August 2013 (Either way, it seems the end result is on its way to become the least favourable outcome in the series to date).

None of this should surprise, given the background of overwhelmingly soft looking economic indicators, that are -equally important- pointing towards more weakness, not improvement in the weeks and months ahead. Some sectors have revealed their vulnerability this month, starting with car-related businesses (virtually all disappointed), with building materials and construction, and even both supermarket operators unable to shake off operational headwinds.

Some retailers managed to stand above the crowd; many others, however, did not. All aged care providers disappointed on a genuine downturn for the sector, despite increased government funding. Regional banks were weak. Outdoor media, clearly, is doing it tough too, as are wealth managers with exception of you know who.

Popular, High PE super-performers who yet again proved their mettle, confounding the many critics on the sideline for the umpteenth time, include a2 Milk ((A2M)), Altium ((ALU)), Appen ((APX)), and Nanosonics ((NAN)). They join the list I pointed out last week, see:

https://www.fnarena.com/index.php/2019/02/21/february-reports-early-resilience-big-disappointments/

Others, including Blackmores ((BKL)), Domino's Pizza ((DMP)), Flight Centre ((FLT)), Hub24 ((HUB)), and Praemium ((PPS)) simply couldn't live up to market expectations.

Equally noteworthy, in the shadow of mostly robust performances from large resources stalwarts, including BHP Group ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)) and Woodside Petroleum ((WPL)), the contractors and engineers are awaiting their moment in the limelight. Investors should keep in mind, nevertheless, this is a sector that traditionally combines outsized investment returns with dismal failures. It wasn't that long ago RCR Tomlinson went bankrupt, just like that, and Lendlease is now looking to divest its own (troubled) engineering division.

This month, services providers including Ausdrill ((ASL)), Alliance Aviation ((AQZ)), Monadelphous ((MND)), and NRW Holdings ((NWH)), among numerous others, provided plenty of confirmation and indications there should be plenty of fresh contracts awaiting in the near term.

On the flipside, companies including iSentia ((ISD)), Ardent Leisure ((ALG)), Asaleo Care ((AHY)), Class ((CL1)), Coca Cola Amatil ((CCL)), Event Hospitality and Entertainment ((EVT)), Fletcher Building ((FBU)), Freelancer ((FLN)), Healius ((HLS)), Mayne Pharma ((MYX)), Pact Group ((PGH)), and many others, once again provided plenty of evidence it is not easy to successfully turnaround a business stuck in struggle street.

On occasion, one such perennial disappointer refinds its mojo, and triggers a successful recovery in the beaten down share price, to the grand delight of long suffering loyal shareholders. This month's turnaround story may well be named QBE Insurance ((QBE)), but we won't know for certain until after the next season in August, if not until after February next year.

All in all, it looks like the end of February will leave investors with a general feeling corporate health and performances in Australia are not mirroring worst case scenarios, but being not as bad, is this good enough to sustain current share price levels?

Ironically, the answer is likely to depend on what happens at the macro level.

Reporting Season: Reality Versus Sentiment

Corporate reporting seasons are important. They provide tangible indications about whether investor sentiment, assumptions and speculation are justified or misguided, but the release of corporate earnings reports never takes place in a vacuum. There are always other factors equally in play, be they macro-economics or geopolitical, or otherwise.

This year, the February reporting season took place against a background of a heavy, four month-long sell-down on the back of slowing growth globally, followed by a swift recovery that took everybody by surprise. That swift recovery was supported by Fed officials reversing their policy outlook towards a more market supportive "neutral" stance, with market participants now anticipating more accommodative policy reversals from central banks across the globe, and expectations of a trade war truce/solution/agreement between the Trump administration in the US and China.

Other factors that equally played a decisive role in February include far from worst case scenarios recommendations in the Hayne report to fix malfeasance inside the sectors of banking, insurance and wealth management in Australia, significant disruption to the availability of seaborne iron ore due to more production problems experienced by Brazil's Vale, and changing dynamics in the local telecom industry as incumbents start preparing for 5G and market share hungry TPG Telecom decided to shelve its own mobile plans on the back of the Australian government banning Huawei equipment, but also intending to merge with Vodafone Australia.

As positive momentum simply begat more positive momentum, equity indices in Australia rose some 13% from the lows around Christmas time, with February adding circa 6% in total return, including the first round of dividend payments. At face value, one would be inclined to conclude everything is hunky dory in the land of falling house prices, collapsing construction of tiny apartments and declining car sales, but when it comes to actual corporate results releases, a different reality opens up.

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On more than one statistic, February 2019 has been one of the worst corporate reporting seasons in Australia post the GFC years of 2008 and 2009. FNArena's statistics only reach as far back as August 2013, but never have we registered more than 27% in companies failing to meet expectations. In fact, 26%-27% has been a rather common statistic during these eleven reporting seasons, accounting for four of the them, and this expands to six (more than half) if we expand the range to 24%-27%.

This year, however, the tally stopped at 33.4%; well above anything recorded in prior years.

Now consider also that analysts had already been lowering forecasts since last year, and that many of February's "misses" were due to rising costs and a more subdued outlook, and it should be clear: corporate Australia is genuinely experiencing challenging conditions. On UBS's assessment, some 15% of companies upgraded their guidance, but 17% of companies guided towards a less profitable outlook.

The numbers released by quant analysts at Credit Suisse look a lot worse, with 16.9% of companies beating expectations, 36.2% missing expectations, and 46.9% reporting in-line. (Different sample & methodology, different results).

Equally unprecedented is the fact that FNArena's average price target adjustment for the season as a whole ended up flat (strictly taken the end result was -0.06%). This too occurred against a background of valuations and price targets already in decline since the prior year. Looking back at the series since mid-2013, average price target increases have ranged between +5.6% in February 2015 and +1.2% in August of that same year.

Never has our calculation for the 300+ companies reporting been flat, let alone slightly negative.

But not everything that happened during February set new negative records. Earnings forecasts dropped lower, but only mildly so and nowhere near the heavy reductions some were fearing beforehand. Here the outperforming sectors were mining companies and contractors to those mining companies.

EPS growth for ASX200 companies fell by a little over -1%, which is quite standard in Australia, leaving average EPS growth now at 3.3% for FY19 with only four sectors providing positive contributions in February: apart from miners, communication, utilities and real estate all forced analysts to upgrade forecasts. Industrials, Financials, Healthcare and Technology were all major detractors to the downside.

Counter-weighting the above average 34.4% in negative disappointments, was a virtually equal 33.3% in positive surprises. Past seasons have taught us corporate surprises ("beats") can run as high as 37% (in February 2018 and February 2016) but our history of eleven prior seasons offers only one prior example when "beats" did not outnumber "misses". It happened in August 2017, when both percentages stopped at 27%.

At face value, this suggests corporate Australia is still very much divided between "Haves" and "Not Haves", separating companies that are in good shape and achieving plenty of progress and profits from others that are struggling with persistent headwinds. It's a theme that has dominated reporting seasons in years past, also bifurcating expert views about "value" versus "growth".

But February 2019 was not simply an extension of trends observed and established in recent years. This time around the boundaries between groups and themes got significantly blurred with many of the registered "positive surprises" actually being a case of "not as bad as feared" while others still managed to put in a decent performance, but it simply was seen as not good enough.

What really blurred the distinction between "Haves/Quality&Growth" and "Not Haves" this February was that, all of a sudden, many that have been in the first group in years past this time around displayed signs of weakness and vulnerability. Combine all of this with extreme cases of share price volatility, in either direction, and it shouldn't be a surprise last month has proved an exceptionally tricky reporting season for investors to manoeuvre successfully.

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Before we highlight some of the individual companies and sector themes that should have investors' attention, let's spend a few more moments on the key themes that stand out from February reports (with thanks to EL & C Baillieu Chief Investment Officer Malcolm Wood):

Sluggish top line growth – at face value the statistics do not look bad, but average growth is being supported by a small group of rapidly growing outperformers. Underlying, argues Wood, average sales growth did not exceed 2.6% which is more than annual inflation, but hardly something to genuinely crow about.

Operational costs are on the rise – this was unmistakably one of the stand-out negative revelations during the season. Whether it be from input costs (energy, raw materials, etc) or from regulatory and compliance costs, or from higher wages, most negative surprises throughout February seemed to have a direct link to companies' inability to keep a lid on rising costs, or to pass it on to customers.

Scarcity of pricing power – inflation the world around remains below central bankers' targets, and a lack of pricing power by companies is showing up during reporting season.

Capital management funded by asset sales – Balance sheets are strong and which shareholder does not welcome a special dividend or share buyback, but Wood points out most are being paid for by asset sales and spin-offs. Great. But where then does future growth come from?

Limited growth prospects – Look beyond the "beats" and "misses" and but a small selection of companies in Australia is pursuing a significant growth agenda or acquisitions. Again, this poses the question: where is future growth coming from? Wood names Amcor ((AMC)), Transurban ((TCL)) and Woodside Petroleum ((WPL)) as positive examples of companies actively engaging in strategies to find additional pathways for growth.

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Anaemic top line growth proved one of the stand-out characteristics of healthcare companies reporting in February with all of CSL ((CSL)), Cochlear ((COH)) and ResMed ((RMD)) failing to meet or beat market expectations and share prices weakened in the immediate aftermath as a result.

In a defensive growth sector that has generated the best investment returns post GFC in Australia, all of a sudden achieving organic growth has become somewhat of a challenge. In addition to the three local market leaders already mentioned, we can add Ramsay Health Care ((RHC)), Healthscope ((HSO)), Healius ((HLS)), Mayne Pharma ((MYX)), and numerous others, including the listed aged care providers, and Ansell ((ANN)) and InvoCare ((IVC)) which are often also put inside the healthcare basket (note Ansell is 50% healthcare at most and InvoCare, well, yes, what can I say?).

One swallow does not a summer make, and one disappointing reporting season does not by definition imply investors are now abandoning the sector in droves, but it remains a remarkable turn of events when a whole reporting season flies by and nobody can remember one single healthcare company that blew the lights out.

Investors should also take into account that, since reporting, analysts have observed CSL continues to outperform its peers globally, suggesting its somewhat disappointing performance in February was not company-specific. The same observations have been made regarding Ramsay Health Care.

As per always, such observation brings out both the bears and the bulls in the share market. Sector analysts at Credit Suisse are worried about a de-rating for the sector over the year ahead, as growth is slowing and valuations remain at a market premium. Their peers at Citi, on the other hand, hold a strong view that share price weakness for quality healthcare stocks offers investors with an opportunity to get on board.

Citi has now upgraded heavily punished Cochlear to Buy with a price target of $198. Before anyone asks: CSL remains a Buy at Citi with a price target of $213. (See Stock Analysis on the FNArena website for all other healthcare stocks).

The rather sober performance of the healthcare sector last month has coincided with similarly less glamorous performances from a plethora of previously highly popular, quality growth business models, enjoying longer term growth trajectories that many would label as "secular". In contrast to prior reporting seasons, companies including GUD Holdings ((GUD)), Carsales ((CAR)), Bapcor ((BAP)), and Orora ((ORA)) this time around were unable to keep the positive momentum alive.

For others, including Blackmores ((BKL)), Bellamy's ((BAL)), Domino's Pizza ((DMP)), Hub24 ((HUB)) and Praemium ((PPS)), the market punishment was much harsher, and to date much more persistent too. It suggests investors have quickly distinguished between popular growth stocks that might have miss-stepped once, but still have a bright outlook, and others for which the future might now look more uncertain and challenged.

Most positive surprises were generated by discretionary bricks and mortar retailers, but the complicating matter here is this was to a large extent because of investors fearing the worst pre-February, a phenomenon described by some analysts as "peak pessimism" preceding results.

On balance, foot traffic in physical stores remains under pressure, sales are increasingly shifting online, and costs are rising here too. With analysts anticipating store rollouts domestically have peaked for most retailers, and margins will continue to face pressure into FY20, this segment is likely to remain tricky at best, and a graveyard for silly aspirations and lost ambitions for many an investor under most scenarios.

For those keen to invest in the sector, stockbroker Morgans' favourites are Lovisa Holdings ((LOV)), Baby Bunting ((BBN)), Adairs ((ADH)), AP Eagers ((APE)), and Noni B ((NBL)).

The many challenges for bricks and mortar retail shops are equally having an impact on the A-REITs sector, where many a landlord is battling sector transformation and decline. On some analysts' estimation, a record number of retail assets are currently up for sale in Australia. This is likely to depress prices, with flow-on impact for valuations of such assets on balance sheets of retail landlords.

The warning here is that "value" can easily turn into a "value trap" under less favourable conditions.

Most sector analysts continue to prefer fund managers, and industrial and office assets operators above retail landlords. Over at Credit Suisse, for example, the ranking order for AREITs post February has been updated to, in order of preference, Goodman Group ((GMG)) -still most preferred though others might consider it too richly valued- followed by Scentre Group ((SCG)), Mirvac ((MGR)), Vicinity Centres ((VCX)), GPT ((GPT)), Shopping Centres Australasia ((SCP)), and Charter Hall Retail ((CQR)), with  Stockland ((SGP)) least preferred.

Irrespective of all of the above, few would debate the fact the stand-out champions of the February reporting season have been large cap resources stocks, miners in particular. Product prices remain higher-for-longer, cash is flowing in and investments are only made in a measured manner. The formula is working to near perfection, at least for the time being.

To many sector analyst, miners remain in a free cash flow sweet spot, which is why shareholders continue to enjoy rising dividends, accompanied by special dividends, and share buybacks. Said mining analysts at Credit Suisse recently: "We cannot recall a time where balance sheets were so undergeared right across the sector."

Underneath the surface, however, rising costs and operational challenges are making their presence felt across the sector. Investors will have to stay agile and focused. The FNArena Reporting Season Monitor for February shows many a smaller cap mine operator disappointed in February, making the sector not a risk free winner for all.

Capex growth from resources (including energy thus) is projected around the 20% growth mark, which bodes well for contractors. Macquarie's favourites are Downer EDI ((DOW)) and WorleyParsons ((WOR)).

A special mentioning remains reserved for a select number of companies that truly has the wind in the sails, with company management doing all the right things, while showing investors true opportunity does not necessarily lay with turnaround attempts at beaten-down share prices, but equally so with Champion stocks at above market multiples that continue exhibiting their quality, ingenuity and strength.

Companies worth pointing out within this context include Magellan Financial Group ((MFG)), Cleanaway Waste Management ((CWY)), Appen ((APX)), Altium ((ALU)), a2 Milk ((A2M)), Bravura Solutions ((BVS)), Goodman Group, Charter Hall ((CHC)), IDP Education ((IEL)), and Nanosonics ((NAN)).

Plenty of others proved why cheap looking share prices were probably appropriate.

February Reporting Season: Final Observations

If there is one conclusion for investors to draw from the recent February reporting season in Australia, suggest analysts at Morgan Stanley, it is that big box retailing is slowly dying in Australia.

Analysis by the analysts has revealed on current trends sales per square meter only grew faster than 2.5% for just three retailers in the February reporting season. This is a red alarm signal given rental costs are growing by 2.5% and labour costs are increasing at 3.5% on a like-for-like basis.

On Morgan Stanley's calculations, labour costs represent between 70%-90% of all costs for Australian retailers.

Even a child can put one and one together and conclude the squeeze is on.

Morgan Stanley's research also suggests consumers are preferring smaller box retailers, while online competition is increasingly taking market share (together with retailers' own online channel). "Should retailers cut back on staffing, opening hours or marketing we think that this likely accelerates the slowdown in sales per sqm growth", state the analysts and with that statement the sector's dilemma has been captured.

The stand-out slowing down story for Morgan Stanley is Dan Murphy's (owned by Woolworths) with the analysts noting the beer, liquor and wine chain has for a long time been the group's growth engine, but now three years in succession have disappointed. On the latest analysis, sales per sqm growth for Dan Murphy's is negative. Foot traffic, point out the analysts, fell -4% to -5% in H1.

The analysts are predicting the next 12-18 months will see stores being closed. Not helping matters, industry data presented by Nielsen suggest high rates of online growth are representative of in-store cannibalisation, with only minimal growth still occurring in in-store sales, point out the analysts.

What makes this latest piece of analysis so painful for both supermarket operators Woolworths and Coles ((COL)) is that, contrary to the trend, both have been closing down smaller locations and opening up larger sized stores in recent years.

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Staying with the local consumer stocks, UBS analysts have made the effort to trying to establish where the market over-reacted post February results, with their analysis suggesting positive share price responses may likely have been out-of-line enthusiastic for Myer ((MYR)), a2 Milk ((A2M)), Flight Centre ((FLT)), Viva Energy ((VEA)), JB Hi-Fi ((JBH)) and Wesfarmers ((WES)); the latter was downgraded to Sell post interim report.

Where investors might have over-reacted to the downside (i.e. these stocks might be worth revisiting), according to UBS, is after results released by Coles Group ((COL)), Treasury Wine Estates ((TWE)), Super Retail ((SUL)), Costa Group ((CGC)), Woolworths, and Kogan ((KGN)).

To set the sector record straight: UBS's three sector favourites are Flight Centre ((FLT)), Treasury Wine ((TWE)), and Metcash ((MTS)). Least preferred are Wesfarmers, Coca-Cola Amatil  and Inghams Group ((ING)).

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Strategists at Morgan Stanley have observed a sharp discrepancy between the local share market performance in February (which was by anyone's account excellent, generating close to 6% return all-in) and the reporting season itself which, on Morgan Stanley's assessment highlighted the intensification of growth and earnings headwinds.

Meanwhile, macro data in Australia continue to weaken and there are suggestions households are deleveraging, thus creating an automatic headwind for companies dependent on consumer spending. The logical observation to add here is that investors, clearly, are drawing confidence from the prospect for one or more rate cuts by the RBA later in the year, or in 2020.

Morgan Stanley strategists are not so sure, and they would "fade such optimism". Their warning to investors: "The downturn underway could be harder to stimulate out of". Apart from a more cautious stance on the local share market in general, Morgan Stanley's Model Portfolio is not inclined to change the underweight exposure to both banks and housing-linked stocks.

If anything, Morgan Stanley thinks the divergence between housing-linked stocks and the broader share market is likely to widen further, not shrink in the months ahead.

Earlier in the month, quant analysis by UBS indicated that, not only have "value" stocks uncharacteristically outperformed during the February reporting season (usually momentum and growth are outperforming), but macro influences have been of larger impact than the actual results. Think the Hayne report and banks, for example, and production loss at Vale.

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While healthcare stocks have been prominently absent from the month's table of best performers, analysts at Morgan Stanley see further downside for shorter-term forecasts. They also point out, the main ASX healthcare names still offer circa 10% 3 year CAGR EPS growth (on market cap weighted average) compared to no more than 4% for the ASX200.

In layman's language these numbers translate into: yes, healthcare stocks failed to shoot out the lights in February, but over the next three years the key sector performers (which includes all of CSL ((CSL)), ResMed ((RMD)) and Cochlear ((COH)) should still outgrow the large majority of ASX200 constituents, so there doesn't appear to be any reason for panic or despair for investors owning these stocks.

In line with comments and views expressed elsewhere, Morgan Stanley preaches caution when it comes to owning private hospital operators.

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