Feature Stories | Oct 09 2019
Download related file: FNArena-Corporate-Results-Monitor-August-2019
The story below is a compilation of stories relating to the February 2019 corporate reporting season in Australia, published between early August and late September. Attached is FNArena's final balance for the season.
Content:
-August Preview: Lower Rates & Lower Growth
-August Reporting Season: Early Progress Report
-August Reporting Season: Early Signals
-August 2019 Verdict: Strength From The Few
-Post-August Afterthoughts
-Dividend Cuts, They Are Coming
By Rudi Filapek-Vandyck, Editor FNArena
August Preview: Lower Rates & Lower Growth
Coming into the August reporting season Australian equities had enjoyed seven months of uninterrupted gains, despite more than 250 profit warnings from ASX-listed companies and with underlying corporate profits (ex-iron ore miners) negative and in decline.
But central bankers are cutting interest rates and reassuring investors they remain ready to act whenever necessary. Combine all of the elements and it was always going to be an open question as to how investors would respond to benign profit results and (most likely) cautious guidance from Australian companies.
In the absence of real and tangible improvement on the ground, but with the prospect of rate cuts triggering a turnaround for Australian housing, and related spin-offs in the domestic economy, investors had been inclined to find "value" in beaten down sectors such as building materials and consumer spending.
But how much leeway would be granted to these companies in case August were to deliver no concrete signals of an actual turnaround?
We will never know the answer as the overriding theme in the first seven days of August has been a resumption of tit-for-tat hostilities between the Trump administration and China, putting the world on notice this battle between the two global economic giants is not about to be resolved amicably or soon.
All of a sudden investors can see the scary prospect of a recession on the horizon, and they are voting with their feet.
All at once heading for the exit door; it ain't a pretty looking picture. And on Tuesday, when I am writing these sentences, the local share market certainly is showing its ugly side.
We might all have had a sense, an inkling, that deep feeling that, maybe, August wasn't going to be just about corporate profits.
Well, our sixth sense has been proven correct. But whereas previously, when things looked a lot rosier from the hilltop with no clouds surrounding, investors might have chosen to grant companies the benefit of potential improvement on the horizon, the concern now has to be that the general turn in sentiment means no prisoners will be taken, and investors might elect to sell first, and revisit later.
If ever one wanted to study the importance of confidence and sentiment for financial markets, August 2019 might be the ideal starting point.
Australia Is Enjoying Growing Profits, But Is It?
Let's start off with the basic ingredients. The Australian share market is one of few worldwide that has enjoyed improving profit growth projections in the first half of calendar 2019, which should be a positive and supportive of its relative outperformance during the period.
But dig deeper and it is all about iron ore. Ex-iron ore, the trend is negative as is projected growth for the rest of corporate Australia, including the all-important banks. Hence, it looks positive from a distance, but it actually isn't.
The more bullishly inclined investor might counter that low expectations means companies are facing a lower hurdle to "beat" during reporting season. The more realistic approach, I believe, is to take into account that expectations are low for very good reason and it is no coincidence this reporting season has been preceded by what most likely has been the largest number of profit warnings recorded post-GFC in Australia.
Baillieu Chief Investment Officer Malcolm Wood has a slightly different set of numbers, but his message sounds remarkably similar. Baillieu counted 63 profit warnings from major ASX-listed companies since early April, representing circa 15% of the ASX100 and 14% of the ASX300.
Discretionary and housing-related sectors have dominated the downgrades in corporate outlooks, but all-in-all the softness has been broad-based on Wood's observation. Profit warnings have been issued by Village Roadshow and Speedcast International, as well as by Ainsworth Gaming, AGL Energy, Flight Centre, Costa Group, Viva Energy, McMillan Shakespeare, Syrah Resources, Citadel Group, Link Administration, Gold Resources, and many more.
In recent trading sessions investor sentiment had been shaken by further warnings from Adelaide Brighton, Graincorp and Bega Foods.
Observation: up until August successful investing in the Australian share market was closely correlated with avoiding profit warnings. This month, however, investors are facing the additional conundrum that market forecasts for the year(s) ahead might prove too optimistic, as illustrated by the following quote from a recent report by stockbroker Morgans:
"We see a strong chance of FY19 results beating low expectations, but market estimates for FY20 look too heroic, leaving scope for some disappointment versus very stretched valuations."
Share Prices Might Have Rallied Too Hard
Are share market valuations too rich?
Consider the following quote from Ord Minnett this week (actually the quote is from JP Morgan, but Ord Minnett never mentions that):
"We have fielded a number of questions regarding whether multiples really are that stretched in light of very low long-term bond yields. In our view, the answer is still yes."
On JP Morgan's analysis, stripping away mining stocks that have been enjoying buoyant iron ore prices, the remainder of the ASX200 was at the end of July trading on 18.7x next year's projected earnings, which equals over three standard deviations above the market's five-year average.
This made JP Morgan strategists rather uncomfortable with the share market entering August, also because the direction of business sentiment is heading south while price momentum keeps on beating every other factor-based share price performance, and in a noticeably dominant fashion.
Against the background of the All Ordinaries' best year-to-date performance since 1991, JP Morgan has stuck with its ASX200 target of 6300; below the 6400 from steadfastly bearish Morgan Stanley.
Such targets suggest the share market might need to have a decent correction first before Australian equities start representing attractive valuations again.
Early Signals Not That Promising
Reporting season in August only ramps up slowly and gradually and it'll be more than a week still until we witness the true tsunami in corporate updates that await investors in Australia this month. Early indications suggest investors better expect plenty of volatility even without further tweets from Trump or central bank announcements.
The first ten profit releases registered by FNArena, starting with Cimic Group in late July, saw only 30% (3 results) of corporate updates "beating" expectations while 40% (4 reports) disappointed. This includes the rather generous inclusion of Rio Tinto with the "beats" on the basis of a larger than expected special dividend, otherwise the early stats would look even less promising.
Apart from Cimic, CYBG, GUD Holdings and Janus Henderson all disappointed and share prices were subsequently sold down. But Credit Corp showed its usual solid self and still saw its shares heading lower after the FY19 release.
In line with my prediction that August would most likely turn into a multi-layered experience for investors, I observe Unibail-Rodamco-Westfield's ((URW)) financial performance was better than expectations but investors remain wary because of medium to longer term challenges for retail landlords.
A special dividend and the potential for a share buy back triggered a rally on the day of reporting for shares in Genworth Mortgage Insurance Australia ((GMA)). ResMed ((RMD)) -high quality performer on a High PE multiple- managed yet another solid performance and its shares jumped 5% on the day.
With a cocktail as diverse as the above, who would dare to make any bold predictions this early in the results season?
Corporate Outlooks In Focus
Current market forecasts are for FY19 EPS growth in the order of 1-2% (including iron ore miners) and for 8-9% in FY20. There is general scepticism about the latter prospect, so corporate guidance and analysts re-adjusting post financial report releases should be closely watched.
Thus far, it remains remarkable but analysts have been extremely busy paring back forecasts for FY19, while leaving FY20 numbers largely untouched.
Adelaide Brighton and Bega Foods had been singled out for potential disappointment by a number of analysts and both companies recently issued a profit warning, vindicating the pre-result analysis. Another company that is regularly mentioned for likely disappointment is Suncorp ((SUN)), alongside Bendigo & Adelaide Bank ((BEN)), Coca-Cola Amatil ((CCL)), Cochlear ((COH)), Coles ((COL)), and G8 Education ((GEM)).
Companies that have multiple analysts expecting a positive surprise include a2 Milk ((A2M)), Charter Hall ((CHC)), Cleanaway Waste Management ((CWY)), and Treasury Wine Estates ((TWE)) though the latter also has a few analysts warning about a potential miss through FY20 guidance. Webjet ((WEB)) is equally a divisive name, as are Flight Centre ((FLT)), Medibank Private ((MPL)) and Aurizon ((AZJ)).
Also noteworthy is popular high flyers including Appen ((APX)), Altium ((ALU)) and Pro Medicus ((PME)) continue to be mentioned for potential outperformance.
Otherwise, the general view is that Australian companies in many sectors are doing it tough, and this should be apparent from financial results and management commentary. RBA rate cuts have come too late to make a serious impact this season, and the same principle applies for the returning Morrison government and/or the weaker Aussie dollar.
See also: "Corporate Earnings Still Matter In 2019"
https://www.fnarena.com/index.php/2019/07/25/corporate-earnings-still-matter-in-2019/
August Reporting Season: Early Progress Report
August is local reporting season for Australian listed companies, but the pace of corporate results releases is so much skewed to the second half of the month that as half-way approaches on the calendar, it remains way too early to draw any definitive conclusions or make far-reaching assessments.
As at Monday, 12th August 2019, the FNArena Corporate Results Monitor still only contains 30 corporate updates. Considering that by month's end the total will have exceeded 300 updates, we have an urge to feel sorry for ourselves. After all, those 300 corporate releases will have to be covered, followed up, updated and summarised. And the slower the season ramps up… you get the idea.
A few early assessments won't go astray (we hope). Corporate Australia clearly is doing it tough. Corporate updates thus far either reveal declining profits, or negative sales growth, or downward pressure on margins, or all three combined.
Subsequent share price responses are often left to management's guidance for the year ahead, potentially supported or negated by hedge funds and other traders taking position prior to the results release.
As such we witnessed Suncorp ((SUN)) releasing a weak result, but with the share price moving higher, and on Friday REA Group ((REA)) missed market expectations, but its share price since put in a notable rally higher. In contrast, CommBank ((CBA)) shares were initially punished upon the release of a weak financial report card, but buyers have since shown themselves.
No such buyers' interest has revealed itself for Insurance Australia Group ((IAG)), whose shares are down quite heavily in a short time, including following the release of disappointing FY19 numbers, and the same observation can be made for Cimic Group ((CIM)), Janus Henderson ((JHG)) and GUD Holdings ((GUD)), whose share prices are all trading significantly below levels prior to the respective results releases.
In the lead-up to August, I predicted investors were most likely to witness a multi-layered experience. The first two weeks are already showing plenty of evidence for this thesis.
We also had a number of major beats, with subsequently solid share price rallies for James Hardie ((JHX)), Pinnacle Investment Management ((PNI)), and Navigator Global Investments ((NGI)). Both ResMed ((RMD)) and REA Group once again proved quality High PE stocks are not necessarily toast, as they have done for many years now.
Continuing on my forecast of a multi-layered August reporting season, Macquarie analysts note companies with direct exposure/leverage to the local housing market have all revealed "headwinds" and tough operational challenges, with each of James Hardie, REA Group, Transurban ((TCL)), CommBank, Mirvac ((MGR)) and Nick Scali ((NCK)) talking the same talk.
But not all housing related business models are similarly vulnerable or operationally exposed with James Hardie and REA Group arguably in a better position than CommBank and Nick Scali.
Macquarie, by the way, continues to recommend investors should buy the dip in selected housing-related businesses, including REA Group, Nine Entertainment ((NEC)), Stockland ((SGP)), James Hardie, CSR ((CSR)), National Australia Bank ((NAB)) and Westpac ((WBC)).
Macquarie's reasoning is that housing will stabilise and subsequently improve on the back of continued RBA rate cuts.
In continuation of recent years, reporting season these days is heavily coloured with capital management (special dividends and share buy backs), as well as with capital raisings. A-REITs in particular are once again using the opportunity to raise fresh capital, but Nufarm ((NUF)), Transurban and AMP ((AMP)) equally have announced fresh raisings.
In terms of general trends, FY19 average EPS growth might not come out too far off the zero mark, predominantly because of another booming performance from resources, in particular iron ore producers and gold miners.
Banks are expected to extend their negative growth period and international industrials are projected to perform significantly better than domestic industrials.
The early data are far from encouraging with decisively more "misses" than "beats" (40% versus 30%) but, as every optimist will tell us, it remains early days.
August Reporting Season: Early Signals
FNArena only started to produce detailed coverage of Australian corporate results in August 2013. In the six years since we haven't monitored one season yet in which released financial performances consist of more "misses" than "beats", but early indications are this August reporting season can possibly turn into "the one".
Having updated on exactly 80 corporate releases on Monday, 19th August 2019, the tally currently stands at 33.8% "misses" (27 reports) against 21.3% "beats" (17 reports) and the remaining 36 reports or 45% in-line.
Of course, there is no real need to get overly downbeat just yet. This is by all accounts still but a relatively small sample. In two weeks' time our daily updated Corporate Results Monitor will contain assessments on 300+ corporate releases, but history suggests it's usually at the end when the real nasties come out while at the beginning of the season, profit warnings not included, the news usually carries a more positive bias.
Not this year, or so it seems. Unless, of course, this is the good news. Let's hope not.
The worst seasons on FNArena's record thus far had both "misses" and "beats" on equal footing. Similar to the US, corporate reporting usually generates more "beats", thus when the numbers end up being equal we all know life for corporate Australia is really, really tough.
Those two seasons were August 2017 and February this year. The latter has also been followed up by an equally "balanced" out-of-season period of lacklustre financial reports, including what might have been one of the busiest seasons for corporate confessions (profit warnings galore). No need to look any further as to why the RBA is cutting interest rates; and why that's exactly what it should be doing.
Quality Retains Its Value
There is no end in sight for the corporate earnings recession in Australia. Early signals thus far are firmly suggesting overall it's not getting better; corporate Australia needs all the support it can muster, with a watchful eye on the multiple international uncertainties.
Not everyone is suffering equally. Observation number one remains the Australian share market continues to be sharply divided between the Haves and the Have Nots; high quality versus low quality, structural growth with a defendable moat versus much weaker and vulnerable business models.
As such we have witnessed, once again, how financial performances from companies including REA Group ((REA)), ResMed ((RMD)), CSL ((CSL)) and Cochlear ((COH)) are holding up reasonably well, and so far these companies' share prices have been rewarded for it.
A similar observation applies to companies such as JB Hi-Fi ((JBH)), Baby Bunting ((BBN)) and Super Retail ((SUL)), operating under maximum stress in a retail sector that is facing multiple challenges, all at once. Here, we can also throw in Smartgroup ((SIQ)), Credit Corp ((CCP)) , Magellan Financial Group ((MFG)) and Treasury Wine Estates ((TWE)); all are proving their mettle when others are faltering.
Plenty Of Vulnerabilities On Show
On the other hand, some of the businesses that had been regarded relatively resilient up until this August reporting season have shown more vulnerability instead and they are being punished for it, including the likes of Orora ((ORA)) and GUD Holdings ((GUD)). One other surprising disappointment was delivered by Cleanaway Waste Management ((CWY)).
Weak performances are thus far what binds together most financials, be they insurers (Suncorp, Insurance Australia Group), financial services providers (Computershare, Challenger), wealth managers (Janus Henderson), small banks (CYBG, Bendigo and Adelaide Bank) or Australia's highest quality lender (CommBank); all updated with soft performances, at best not disappointing too much to the downside, or trying to placate investors with a higher dividend.
Even the resources companies report card thus far looks rather mixed with Rio Tinto ((RIO)) also feeling the need to compensate for slight disappointment with a higher dividend but with Woodside Petroleum ((WPL)) disappointing on both accounts. Both Whitehaven Coal and Coronado Global Resources ((CRN)) performed well but remain beholden to whatever happens to the price of coal.
Observation number two is that FY19 report card driven share price volatility can be quite extreme, as has been the case in all reporting seasons in recent years. Probably the most puzzling sell-off followed a much better-than-guided performance by Jumbo Interactive ((JIN)). Post event weakness might be related to one large seller who's keen to abandon its holding, in which case a recovery most likely will follow once the majority of stock has been offloaded.
Both Blackmores ((BKL)) and Pact Group ((PGH)) are likely to feature on the list of most prominent failures this season, together with AMP ((AMP)). All three have repeatedly proven in recent years that a falling share price does not by definition represent an opportunity for bottom-dwelling investors, and that story has simply continued into this month.
JP Morgan Finds August Challenging And Puzzling
Equity strategists at JP Morgan point out while star performers such as JB Hi-Fi are managing to withstand the pressure from "recessionary" conditions for Australian retailers, in reference to a description used by the South African owners of David Jones, there is no such escaping the retail blues for landlords including GPT ((GPT)) and Vicinity Centres ((VCX)).
JP Morgan has found the opening gambit to the August reporting season "puzzling", providing "little clear direction on the state of the economy". The strategists note similarly mixed messages from companies exposed to the local housing cycle, while demand for credit overall seems to be subdued, still.
One thing stands out: JB Hi-Fi is most likely to surprise to the upside when it reports financials. JP Morgan has six years and twelve reporting seasons to back up that observation. Something to keep in mind for next February, maybe?
JP Morgan goes as far as call August an "unhappy hunting ground for Australian equity investors" and notes the month has seen only one positive performance in the past six reporting seasons. Similar as with FNArena's observations, JP Morgan's stats equally show more misses than beats, but also with only a tiny group of companies forcing analysts to revise forecasts upwards. Healthcare is the standout sector so far.
Coincidentally, that one positive August season was last year when healthcare stocks, led by a 15% rally in CSL shares, were equally among the standouts.
Dividends Still Growing
Elsewhere, Janus Henderson reports the more challenging context for companies globally is having an impact on global dividends. On its numbers, total dividend payouts reached a new all-time record in Q2 of US$513.8bn, but this only marks an increase of 1.1% compared to a year ago (when dividends were growing at 14%+). The rate of growth is slowing noticeably, though this is also due to the impact from a stronger USD.
Janus Henderson had already anticipated a slowing pace of growth in total dividend payouts, with Europe in particular lagging the rest of the world. Janus Henderson's dividend index for the continent is at its lowest level in over a year. Australia remains inside a five-year long trend of stagnant dividend growth with QBE Insurance ((QBE)) the only bright spot locally ahead of August reporting.
For 2019 as a whole, Janus Henderson is forecasting 4.2% growth in dividends to a total payout of US$1.43trn, equal to 5.5% growth underlying; in line with the long term trend.
August 2019 Verdict: Strength From The Few
By Rudi Filapek-Vandyck, Editor FNArena
On the micro-level, a failed or splendid financial performance release can have a noticeable impact on a company's share price up to three months down the track.
On the macro-level, recent observations suggest beats and misses can set new trends for sectors and broad themes, or keep the momentum going for longer.
With the August reporting season revealing more weakness, and most performance disappointments, from laggards and cheaply priced companies, the obvious conclusion might be it remains way too early to predict the downfall of highly priced, rapidly growing performers.
Patient investors in lagging building materials companies, retail landlords, listed professional value investors and small cap financials might have to be patient for longer.
If I restrict my memory to the past two years, investors turned cautious and sceptical ahead of the February reporting season in 2018, but were subsequently blown away by results released by Appen, Altium, WiseTech Global, CSL, ResMed and most other highly popular, High PE growth stocks which then re-launched the momentum for Growth in the share market until the following August, when the scenario pretty much repeated itself.
We recall that CSL shares rallied no less than 15% after updating its financials that month, which only broadly met expectations at the time.
Then followed a nasty and volatile downturn. By February this year, the previously virtually untouchables, including ResMed, CSL, etc, started releasing financial reports that either missed expectations or proved merely OK. This then, of course, begged the question: has the time finally arrived for cheaper priced "value" stocks to have their moment under the sun?
It turns out, that swing in momentum hardly made it into August. Even miners and energy companies merely showed their weaknesses throughout last month, disappointing on multiple levels except when larger dividends and share buybacks had been announced, which in itself poses a few questions regarding operational performances against cost controls and boards inclined to offer compensation.
General weakness in commodity prices exacerbated the weakness in share prices. Right at the cut-off of reporting season, nickel popped up as the against-the-general-trend exception, alongside gold.
As things turned out, corporate Australia is in a vulnerable state with plenty of sectors battling multiple headwinds. Against this background, good old bricks and mortar retailers delivered the stand-out, positive surprise in August. Their performance was matched by the High Quality names of CSL, ResMed, REA Group, Altium, WiseTech Global, Goodman Group, Charter Hall, and numerous others.
But nothing can mask the cold hard impartial observation that August 2019 marks the weakest reporting season since August 2013, when FNArena started keeping detailed records and stats. We didn't know it at that time, but August 2013 was a pretty weak reporting season. August this year has, for the very first time since we keep records, generated more "misses" than "beats" in the corporate results releases.
If we combine the recent reports with the fact that both preceding reporting seasons in 2019 (February and March-July) only saw total "beats" equalling "misses" on each occasion, one can only conclude things are incredibly tough and challenging for large parts of the Australian economy. Judging by the latest update, the broad trend is not improving either.
We can all but wonder what exactly the impact could have been on the local share market if the general background was not made up of central banks loosening policies, including the RBA, and a global investment community thirsty for yield. A weakening Aussie dollar will be keeping hopes alive that more of the benefits will start showing up in the six months ahead.
August Report Card
Few will criticise or deny, some of the strongest performances in August were released by CSL ((CSL)), WiseTech Global ((WTC)), AP Eagers ((APE)), Infomedia ((IFM)), IPH ltd ((IPH)), James Hardie ((JHX)), Magellan Financial ((MFG)), Medibank Private ((MPL)), Pro Medicus ((PME)), and ResMed ((RMD)).
Special Note: none of these companies fall into the category of cheaply valued stocks.
Strong performing retailers include Accent Group ((AX1)), JB Hi-Fi ((JBH)), Baby Bunting ((BBN)), and Shaver Shop ((SSG)) while all companies in car leasing and salary packaging came out solidly too with Smartgroup ((SIQ)) and McMillan Shakespeare ((MMS)) taking sector honours.
Companies that proved the doubters wrong include Bapcor ((BAP)), Treasury Wine Estates ((TWE)) and Lendlease ((LLC)).
Companies that in particular disappointed include Boral ((BLD)), Brambles ((BXB)), Bellamy's ((BAL)), Blackmores ((BLK)), Cimic ((CIM)), Citadel Group ((CGL)), Cleanaway Waste Management ((CWY)), Costa Group ((CGC)), CYBG ((CYB)), G8 Education ((GEM)), Ingham's Group ((ING)), Insurance Australia Group ((IAG)), Orora ((ORA)), Pact Group ((PGH)), and Virtus Health ((VRT)).
But nothing compared to the Big Question Mark that is now attached to Pioneer Credit ((PNC)), Smiles Inclusive ((SIL)) and Speedcast International ((SDA)). Serious questions also persist for Corporate Travel Management ((CTD)), Collection House ((CLH)), and Virgin Australia ((VAH)), while patience must be running out for shareholders in value-investors on the wrong side of history, including Platinum Asset Management ((PTM)) and Perpetual ((PPT)).
Miners and Energy producers largely failed to impress, delivering rather mixed performances with positive stand-outs delivered by Santos ((STO)) and Origin Energy ((ORG)), as well as some of the coal producers, but the sector offered plenty of disappointment including from Iluka Resources ((ILU)) and BlueScope Steel ((BSL)).
Among High Growth, High PE names a2 Milk ((A2M)) surprised against the trend negatively, on the need for increased investment, and Domino's Pizza (DMP)) has ceased providing guidance, having now missed it three reporting seasons in a row. IDP Education ((IEL)) got punished severely, which also happened to Nearmap ((NEA)) shares. Jumbo Interactive ((JIN)) experienced similar, but that lasted but a brief moment.
Plenty of potential turnaround stories delivered yet more evidence any turning around might require a lot more time, and maybe a good chunk of luck too – see also last week's Weekly Insights. Financials in particular stood out with plenty of weak results.
Investors should be aware market speculation has it Westpac ((WBC)) is considering raising additional capital in order to prevent having to cut its dividend while recent regulatory tightening by APRA has singled out ANZ Bank ((ANZ)) as possibly most at risk from forthcoming regulatory tightening in New Zealand. This is why shares in Commbank ((CBA)) and National Australia Bank ((NAB)) have been the better performers in the sector recently.
See also "Capital Controls Another Knock To Banks" published on Tuesday:
https://www.fnarena.com/index.php/2019/09/03/capital-controls-another-knock-to-banks/
(Most) Trends Are Negative In Australia
In terms of underlying trends, the momentum in earnings forecasts is negative, was negative prior to and during August and is expected to remain negative in the lead-up to the February reporting season next year. According to AMP's chief economist Shane Oliver earnings downgrades during August have dominated by more than two to one versus upgrades.
Earnings downgrades have been greatest among energy stocks, financials, telcos and industrials. Ultimately, the dial stopped at 1.5% growth in earnings per share for FY19, but without resources it was negative: -2%. Forecasts for FY20 have now fallen to an average of 6.3%, but it shouldn't surprise to see this halve, or worse, by this time next year.
Oliver also reports only 58% of companies have seen earnings rise from a year ago compared to 77% this time a year ago. In addition, only 49% of companies raised their dividends, well below the norm of 62%, while 28% of companies cut their dividends, the most in the last seven years.
FNArena counted 65 upgrades in stock-specific recommendations in relationship to released profit reports, while 71 downgrades were issued. The average consensus price target rose by 2.49% throughout the month. As stated earlier, never before did we witness a local reporting season wherein more companies missed expectations than managed to beat them. The final percentages stand at 24.4% (77 companies) "beats" versus 25.3% (80) "misses".
Historically, the near 2.5% increase in targets doesn't look too bad (but it hides the sharp bifurcation behind the average) while total misses are on the high side. The percentage in "beats" is the lowest recorded for any reporting season since 2013.
CommSec & UBS
Some additional insights are worth highlighting from analyses published by CommSec and UBS to wrap up the August reporting season. CommSec limits its research to constituents of the ASX200 of which 138 released full year numbers in August and 31 others published interim reports. UBS stays within the boundaries of those stocks that are actively covered by its own analysts.
A high number of 92% of companies reported statuary profits, on CommSec numbers, which is above the long term average of 88%, but only 52.2% of those companies managed to grow their profits. More companies -88.4% versus the average of 86%- elected to pay a dividend to shareholders.
CommSec reports the 52.2% is better than the February reporting season earlier in the year when only 48.6% managed to grow profits from a year earlier. February marked the second lowest percentage on this measure since 2010, only beaten to the downside by August 2011.
In aggregate, revenues lifted by 6% but expenses (costs) rose by 6.8%. And while dividends increased by 4.9%, CommSec numbers reveal aggregate cash generated fell by -0.1%. Also, dividends in total only grew because companies including Rio Tinto, ASX, Coles and Medibank Private paid out special dividends. Excluding these, aggregate dividend payments fell by -0.6%.
Of those companies paying out a dividend, 21.3% cut the dividend and 23.8% kept dividends unchanged. The 54.9% that chose to pay out a higher dividend represents the smallest proportion in around six years on CommSec data. All in all, these numbers suggest it has been a tough six months, if not twelve months for corporate Australia, which is also the view of CommSec.
Analysts at UBS are decisively more blunt about it, calling August "a reporting season to forget". The weakest in six years, on UBS's assessment, and the timeline only stops there because that's when the current team starting gathering stats and records. Incidentally, CommSec suggests it may well have been the weakest season on record for the past decade.
Maybe we should simply call it possibly the worst performance we all have witnessed in Australia post GFC?
FY19 achievements were generally weak, highlights UBS, but on top came generally soft forward guidance. The upgrade-to-downgrade ratio for August stopped at 0.6; the lowest in five years. A minority managed to trigger noticeable upgrades to forecasts. Most results were followed-up with reductions.
UBS still thinks FY20 forecasts remain too high, in particular for Financials, but the analysts also concede ultra-low interest rates do offer compensation.
UBS was mostly pleased by the fact that 36% of large cap companies beat expectations on dividends, while only 15% missed. Playing the Devil's Advocate here, is this not merely a sign these boards felt they had to put in an extra effort to compensate for disappointment elsewhere?
The trend in earnings revisions remains decisively negative and UBS highlights once again Resources remain the offset while Industrials ex-Financials are currently trending well below average. For Financials, current negative EPS revisions are the worst since the GFC on UBS's numbers.
Post revisions, market consensus now expects 6.3% market EPS growth in FY20, with strongest outlook for Resources (+9.2%), then Industrials ex-Financials (+8.4%), with Financials (+3.7%) the weakest.
UBS thinks the more realistic outcome will be for 3% EPS growth, supported by Resources, implying Industrials, but more so the banks and other Financials are likely to remain subjected to downward trending forecasts.
Share Market Valuation
The August reporting season is unlikely to stop the public debate about whether share prices are too richly priced, or not. On FNArena's observation, index weakness in August and in early September means only a minority of the circa 400 active ASX-listed stocks in our database are trading above consensus target.
While this includes regular and obvious offenders such as WiseTech Global, Cochlear and Altium, it also applies to portfolio staples such as Woolworths ((WOW)) and Wesfarmers ((WES)). In broad terms, most ASX-listed stocks that are on most investors' radar are trading below consensus target.
The obvious comment to make here is that none of these targets incorporate the prospect of an economic recession, here in Australia or elsewhere. Given ongoing risks globally, this is something investors should bear in mind. Ditto for prospective earnings growth potential and dividends.
If we look at where the Big Four banks are at, we notice CommBank shares are trading solidly above target, while National Australia Bank is above and Westpac close but below its target. ANZ Bank is the current laggard in the sector leaving a gap of a little less than -4%.
Assuming the Big Four can still be used to assess investor sentiment in general, I'd be inclined to suggest overall sentiment remains elevated, but not extremely so. Given risks have definitely risen for local banks, also see above, there is but a fair argument to be made share prices should be lower, not higher in the short term. Whether this also applies to the share market in a broad sense is likely to be determined by macro factors and uncertainties.
Craig James and Ryan Felsman, economists at CommSec, agree with my assessment that Australian shares may not be as bloated on valuations as it may seem at first sight, also considering central bankers in support and exceptionally low bond yields. CommSec expects the All Ordinaries to range between 6700-7000 by year-end, while the ASX200 is expected to range between 6600-6900.
UBS analysts note High PE Growth companies have been among the better performers in August, both on results and in share prices, which means the Top End of the Australian share market is now trading on an average Price-Earnings (PE) ratio of 25x, a new cycle high.
All-Weather Portfolio Performance
In line with all of the above, the FNArena/Vested Equities All-Weather Model Portfolio significantly outperformed the broader share market in August with several portfolio constituents posting sizable rallies upon releasing financial results. Only a small number genuinely disappointed.
Whereas the ASX200 Accumulation Index dived deep in the red, and recovered somewhat during the final days of the month, to post a -2.36% loss following a positive performance of 2.94% in July, the All-Weather Portfolio posted gains of 2.95% in July and 0.47% in August.
The combined performance for the All-Weather Portfolio over the first two months of the new financial year is thus 3.43% compared with 0.52% for the ASX200 Accumulation Index.
As reported last week, we made several changes to the Portfolio to reduce the cash balance, while increasing exposure to yield/income, but not to the share market. More about this next week.
Post-August Afterthoughts
In a post-August review, analysts at UBS repeat yet again what a weak performance it was from corporate Australia and small caps contributed with full gusto to the generally dismal performance.
On UBS's calculations, the average small cap profit growth performance amounts to a negative -7% EPS growth in FY19. Clear message: the lack of profit growth momentum on the ASX is not purely a large cap phenomenon.
UBS equally repeats one of my own favourite statistical observations: in Australia, contrary to the USA, small caps do not generally outperform the large caps in terms of average investment returns. Having said so, on UBS's assessment, the relative discount for small caps versus large caps has widened in Australia to the largest gap since 2012.
On pure statistical impetus, this could mean it might be a good time to add more small caps exposure to investment portfolios. UBS modelling suggests a potential outperformance of 3% relative to large caps could be on offer.
UBS research suggests investors might consider adding Appen ((APX)), Imdex ((IMD)), Myer ((MYR)), Nanosonics ((NAN)) and NRW Holdings ((NWH)). Stocks to avoid include GUD Holdings, Japara Healthcare ((JHC)), Mayne Pharma ((MYX)) and Speedcast International ((SDA)).
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Michael Knox, at stockbroker Morgans, makes the following observation in his post-August review:
"It's interesting to note the recent fall in companies growing their dividends, while the number of companies cutting dividends has stepped up slightly. We think investors need to be conscious of this creeping trend of both EPS and dividend disappointment."
Could not agree more. As a matter of fact, I intend to spend more time on this observation myself. Consider this a promise for personal follow-up.
Post reporting season Best Buy Ideas as selected by Morgans among large cap stocks are Telstra ((TLS)), Wesfarmers ((WES)), Woodside Petroleum, Sydney Airport ((SYD)), Orora ((ORA)), Cleanaway Waste Management, ResMed, Sonic Healthcare, Treasury Wine Estates, Aristocrat Leisure and OZ Minerals.
Best Buy Ideas among small caps involve Afterpay Touch ((APT)), Lovisa Holdings ((LOV)), AP Eagers ((APE)), Over the Wire ((OTW)), Kina Securities ((KSL)), PWR Holdings, APN Convenience Retail REIT ((AQR)), Orocobre ((ORE)), Volpara Health Technologies, SomnoMed ((SOM)), Otto Energy ((OEL)), Cooper Energy ((COE)) and Sundance Energy ((SEA)).
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Over at Macquarie, analysts noted the August reporting was a tough one for contractors to the resources sector. Macquarie observed a plethora in "relatively vague outlook statements".
Upon further reflection, the analysts do believe the macro picture should remain positive for the sector, with both resources companies' capex plans and the level of infrastructure spending holding up.
Macquarie only covers a relatively small selection of listed contractors in Australia. Of those, its current sector favourite is Downer EDI ((DOW)), followed by WorleyParsons ((WOR)), Cimic ((CIM)), and then Monadelphous ((MND)).
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Small cap retail specialists at Citi reshuffled their sector preferences post-August and the result is that restructuring New Zealand born jewellery retailer Michael Hill ((MHJ)) is now the most preferred small cap retailer on the ASX. Citi clearly is banking on the fresh CEO getting the execution done well.
The former sector favourite, Lovisa Holdings makes a big fall down the sector rankings to now have become the sixth most favourite small cap retailer investment opportunity in Australia. Mind you, Citi still labels Lovisa the "best long-term growth story" in the local market, at least among small cap retailers.
Michael Hill beats (in order of updated sector rankings) Baby Bunting ((BBN)), Super Retail ((SUL)), Accent Group ((AX1)), Beacon Lighting ((BLX)), then comes Lovisa, followed by Premier Investments ((PMV)), Harvey Norman ((HVN)), City Chic Collective ((CCX)) and Myer, with Nick Scali ((NCK)) closing the list.
Rudi's View: Dividend Cuts, They Are Coming
At face value, the August reporting season in Australia was disappointing, but not quite negative enough to spook investors into a general flight out of Australian equities. Enough evidence came from the likes of JB Hi-Fi and Super Retail that consumer spending might be on a little up-swing, and the general expectation remains the downturn in property markets should prove relatively short-lived.
In the background, central bankers are still re-stimulating economies and financial markets are sharing the view the recessions many see coming will be avoided on the back of low bond yields and ever lower cash rates.
Against this backdrop, corporate earnings in Australia managed to squeeze out a tiny gain from twelve months ago, on average, albeit heavily supported by higher-for-longer iron ore prices and a resurgent gold sector. Expectations are the year ahead is likely to simply offer much of the same; low growth for most companies, in particular from the old economy stalwarts, with mining and energy the potential swing factor.
So far not too bad, or so it appears, but maybe the true story is hiding in the dividends?
FY19 Dividends Look Like 'The Peak'
Again, at face value, aggregate dividends in August were up 4.9% from last year, even though we needed special dividends from the likes of Rio Tinto and Fortescue Metals as well as additional payouts on the back of asset sales (Brambles, etc) to get there. Even including these "extras", the contrast with the context one year ago is rather stark. Last year, aggregate dividends were growing by 14%.
Underlying, total dividends corrected for such one-offs actually went backwards. Because most of the attention during reporting season goes out to profits and company outlooks, and the subsequent response in the share price, most investors would have missed the fact that, at the individual level, no less than 23 members of the ASX200 index either cut or completely scrapped dividends in August.
Among the companies whose shareholders received less than they were probably expecting are the likes of IOOF Holdings ((IFL)), Perpetual ((PPT)), Suncorp ((SUN)) and AGL Energy ((AGL)); in each case the running yield this year and in years past is high enough to assume many a yield-seeking investor was affected.
On the flipside is the observation that while August 2019 in many regards represents the worst reporting season for Australian companies post-GFC, a noticeable number of surprises came in the form of a larger-than-expected dividend payout. On UBS analysts' assessment, a net 21% of large cap surprises came in via a higher dividend (or a share buyback).
The implicit suggestion from UBS's observation that company boards have sought to placate shareholders by paying out more than otherwise might have been the case falls in line with CommSec's observation that 88.4% of full-year reporting companies elected to pay out a dividend in August. This percentage is above the 86.3% average over the 19 reporting seasons covered by CommSec.
Note that total dividends increased by 4.9% from a year ago in August but growth in costs outpaced sales increases over the period, and many large caps reported profits going backwards.
This realisation triggered my investigation into what might lay ahead for the income hungry investor in the next twelve months. Judging from analysts' forecasts, it would appear investors better not casually dismiss the beneath-the-surface dividend message from August; there are more cuts coming, and relatively soon too.
Knock. Knock. Who's There? Your Next Dividend Cut!
Somewhat surprising, maybe, there appears to be a higher proportion of anticipated dividend cuts among the out-of-season reporters; companies that release financial results between September and year-end. And yes, this also includes CYBG ((CYB)), Bank of Queensland ((BOQ)) and Westpac ((WBC)) among the banks.
Investors should note National Australia Bank ((NAB)) already cut its dividend earlier in the year while CYBG issued a profit warning in early September.
Other companies that are slated to reduce dividends from last year's payout, according to analysts' expectations, are Pendal Group ((PDL)), EclipX Group ((ECX)), Nufarm ((NUF)), Incitec Pivot ((IPL)) and Graincorp ((GNC)). I suspect this list hasn't raised many eyebrows given most of these companies have either issued a profit warning or already indicated their intention to pay out less to shareholders this year given corporate hardship. Not many shareholders would be on these registers looking for steady income.
But this is how quickly the 23 dividend cuts from August can accumulate to 33. And analysts are expecting at least ten more from companies that close off their financial books in December, meaning they should announce lower dividends before or in February next year.
Here the list includes G8 Education ((GEM)), AMP ((AMP)), Alumina ltd ((AMP)), Iluka Resources ((ILU)), Caltex Australia ((CTX)), oOh!media ((OML)), Spark Infrastructure ((SKI)), OZ Minerals ((OZL)), Costa Group ((CGC)) and Adelaide Brighton ((ABC)). Note that if all these forecasts prove correct, a total of 43 companies will have reduced shareholder dividends from a year earlier by the time financial year 2019 has been put to rest for all companies that make up the ASX200.
Still, this story is not over yet. If current expectations are accurate, there will be more cuts forthcoming in 2020. Companies that are expected to join the negative trend in dividend payouts by August next year include South32 ((S32)), Fortescue Metals ((FMG)), Boral ((BLD)), Inghams Group ((ING)), Challenger ((CGF)), Harvey Norman ((HVN)), Metcash ((MTS)), Link Administration ((LNK)), Insurance Australia Group ((IAG)), Brambles ((BXB)), and others.
Investors Should Heed The Dividend Message
To be fair, there is probably little to be gained from selling out of stocks simply because of these projections. In particular for those companies that are scheduled to report their financial results relatively imminently (Pendal Group, the banks). Remember, these are all forecasts by stockbroking analysts. The professionals in the market are aware of it.
Nevertheless, I think investors should heed the message of the underlying trend, which shows a clear and resounding: more bad news is coming, the risks remain to the downside. Don't forget: while analysts forecasts can be too negative, they also can underestimate the extent of a company's weakness and vulnerability. Most companies that end up scrapping their dividend were initially expected to only temporarily reduce their payout.
Next comes the great unknown: with so many companies projected to reduce or suspend their dividend, who could possibly make such a move out of left field? Arguably, this can potentially have a significantly larger impact on the share price, as the announcement will be unexpected.
Equally possible is that investors are solely concentrating on where bond yields are with the ongoing prospect of further RBA rate cuts, which might imply some of the share prices mentioned could be artificially supported and only face consequences later on. After all, these are mostly forecasts at this stage (not necessarily supported by all analysts).
Equities Move In Correlation With Cash Dividends
From a macro-perspective, I think the scene is set for a contraction in aggregate dividend harvest for Australian investors in the year ahead. This is not something that happens regularly. Post GFC, it only happened in 2015 and I am sure most investors remember that was not a buoyant time for the share market. Coincidentally, the RBA was equally cutting the cash rate back then and plenty of worries about the international outlook dominated investor sentiment.
Of equal importance is that research published by analysts at Citi earlier this year (see "All About Dividends", Rudi's View, May 16, 2019) suggests quite a close correlation exists between cash dividends paid out to shareholders and the performance of equity markets in general.
Irrespective of whether further RBA cuts will manage to stave off economic recession in 2020/21 (and most importantly: ditto for the Fed and the US economy), if the identified close correlation remains in place, then maybe investors should temper their expectations for the local market, unless the economic picture improves considerably.
A recent update by quant analysts at Credit Suisse suggests updated forecasts post August imply total dividends in the year ahead could drop by as much as -12.8%, with mining companies continuing to contribute positively (as they have over the past two years).
As for whether the outlook for Australian dividends will improve by this time next year, we all simply have to wait and see. For a large number of companies, dividend cuts are usually a one-off, followed by stabilisation or a resumption of growth. Look at the local banks, for instance. But in some cases one cut marks the start of a more prolonged period of downward pressure.
The latter seems to be the case currently for companies including IOOF Holdings, Inghams Group, Suncorp, Bank of Queensland, Platinum Asset Management ((PTM)), Sims Metal Management ((SGM)), New Hope Corp ((NHC)), CSR ((CSR)), Blackmores ((BKL)), Aveo Group ((AOG)), Sigma Pharmaceuticals ((SIG)), G8 Education, Iluka Resources, Caltex Australia, oOh!media, and AGL Energy.
On a related, but slightly off-topic subject, Bell Potter's Richard Coppleson reports next week sees the by far largest payout in dividends from the August reporting season in Australia. At an estimated payout of $12.7bn next week dwarfs all other weeks, representing circa 45% of the $28.28bn in estimated total payouts this month and next.
For those who like statistics: circa 180 companies in the ASX200 pay out a dividend each year to shareholders, excluding a few NZ based companies for which we have no data.
(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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