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Rudi’s View: February Reports – Optimism Is Back

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Feb 07 2020

This story features G.U.D. HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: GUD

Dear time-poor reader: early indications are investors are willing to adopt an optimistic view this reporting season

This is Part Two of this week's Weekly Insights, see also further below.

February Reports: Optimism Is Back

By Rudi Filapek-Vandyck, Editor FNArena

If Mr Market were a person of flesh and blood, he/she would have returned from the December holiday with a joyful spring in the step.

Expectations are 2020 will be a better year for global economic growth and for corporate profits after both trended down throughout calendar year 2019.

Extremely loose policies by central banks, including in Australia, the US and China, plus a reduction in geopolitical tension have laid the groundwork for a recovery later into 2020, so goes the narrative, and early economic signals are providing the necessary support for it.

This easily explains the unusual exuberance during the first weeks of January this year, until an unexpected coronavirus outbreak in China caused a pause in the uptrend.

Given the apparent validity behind this new narrative, and investors' willingness to get set six to nine months ahead, it seems unlikely the latest virus scare can fully derail the share market's newfound optimism. But investors will still be looking for as much confirmation as they can get along the way.

This is where the February reporting season fits in perfectly. Times have been tough for many a domestic-oriented retailer or cyclical company. Share prices are up (for most). Now investors want to receive some comfort from businesses their money is parked with the right people.

This set-up makes some experts uncomfortable, fearing too many businesses won't be able to deliver. And broad indices have only just touched at new all-time record highs. However, reading through copious amounts of previews and updates on ASX-listed corporates, I sense a general preparedness to look beyond the occasional niggle and short-term challenge.

Investor responses to early financial report releases have been encouraging: it's not the tangible evidence of the big turnaround we are all looking out for; we simply want enough comfort that things are starting to look up, and that management will be able to deliver.

An early update delivered by car parts manufacturer GUD Holdings ((GUD)) looks highly encouraging, indeed. Strictly taken, the six monthly financial performance missed analysts' expectations, but management was able to provide enough assurance that things are improving, and the next six months should make up for the initial "miss".

GUD Holdings shares have risen every day since reporting on February 2. Even though earnings forecasts have fallen slightly, the consensus target price has lifted to $11.95 from $10.72 on the day of reporting. Prior to that day, the shares had already recovered some 40% from the low point in August last year.

If the experience of GUD Holdings can be extrapolated over the remainder of February, the Australian share market is in for a treat, with plenty of positive vibes looking promising for the laggards in the market, those stocks the professionals like to label as "value stocks".

This by no means implies highly valued growth stocks automatically fall out of favour. The performance bar might be a tad higher, but that hasn't stopped many a structural growth performer from reaching fresh all-time highs. ResMed ((RMD)) is traditionally among the early reporters in Australia and its financial update was, yet again, better-than-expected. No reason to start worrying here.


The Big Dip Lays Behind Us

To understand the comfortable optimism with which investors are embracing this year's February reporting season, we must look back at what happened in August last year.

On many metrics, August 2019 marked the worst performance by corporate Australia post-GFC. Average profit growth for FY19 came out below zero. Aggregate dividends went backwards for only the second time in the decade. And if all that wasn't depressing enough, the subsequent banking reporting season saw Bank of Queensland ((BOQ)), National Australia Bank ((NAB)) and Westpac ((WBC)) all cut dividends for shareholders.

No surprise, the pendulum of share market momentum swung swiftly back to reliable, sustainable and predictable performers such as CSL ((CSL)), REA Group ((REA)), and Woolworths ((WOW)).

The Big Dip in the second half last year put the brakes on the broad market with the ASX200 only adding an additional 3% in total return on top of the circa 20% accumulated over the first six months. Underlying, trends and performances returned to their polarised divergence from 2018.

Then came the bushfires, and things were really not looking that rosy. In an ultra-rare occurrence, negative December didn't even allow for the traditional Santa rally leading into the new calendar year.

It's Not A Bubble

If the trend stops worsening, things can actually start getting better. Investors believe there are sufficient signals and indications, historically and otherwise, suggesting the outlook is for better performances later in the year. Witness, for example, how the release of disappointing retail sales numbers for December on Thursday was mostly greeted with a shrug of the shoulders.

Most importantly, the 2020-will-be-better-thesis doesn't rely on a Big Turnaround. Only a small uplift from last year's trough should do the trick. Even the IMF and the RBA are on side, judging by their latest statements.

But what about those elevated share prices, I hear you ask. Are we not witnessing a share market bubble much greater than the 1930s in stocks like CSL, Xero ((XRO)), Afterpay ((APT)), Woolworths, and Wesfarmers ((WES))? What should a prudent investor do in the face of Price-Earnings (PE) ratios beyond GFC highs, and for some at never before witnessed multiples?

Market analysts at UBS calculated recently the average PE ratio for industrials ex-financials in Australia has re-rated upwards to a multiple of 25x. They think this is the highest multiple seen in Australia since at least the 1930s. But to accurately assess today's stock valuations one also has to take into account that long-term bond yields are at exceptionally low levels. Low bond yields push up valuations elsewhere.

Investing in the share market today is attractive on the premise that bond yields will not make a sudden step-jump higher in the foreseeable future. Were this to happen, it wouldn't just hit the share prices of quality and growth stocks, but of share markets generally. And as witnessed during the brief bear market of late 2018, cheaper laggard stocks will fall just as hard as those that have outperformed.

This is the cloud of uncertainty that will simply never go away in its entirety.

Investors Looking Beyond Short Term

So how are we positioned for February 2020?

The broad Australian share market is estimated to deliver growth in earnings per share (EPS) of between 3%-5% in FY20 (depending on one's view about commodity prices). This looks a lot better than the negative number for FY19.

Earnings estimates have been trending upwards leading into February, but only because of upward adjustments to forecasts for resources companies. Ex-miners and energy producers the underlying trend remains negative, albeit predominantly because of small cap stocks that have been hit by bushfires, lacklustre consumer spending or the coronavirus fallout.

Usually, adjustments during reporting season pull the estimated pace of growth down, but this year some analysts are optimistic that by March average growth expectations might have actually increased slightly. We'll have to wait and see.

Solid contributions are expected from the technology sector and from general industrials, which also includes healthcare and the food and beverages sector. Financials are expected to perform weakly and that goes for banks, as well as for insurers, as well as for asset managers.

Health insurers in particular seem under the pump with both nib Holdings ((NHF)) and Medibank Private ((MPL)) having issued a profit warning. Airlines, airports, tourism and leisure operators, as well as casino owners are all expected to issue cautious statements due to the known unknowns from the coronavirus impact.

One of the topics of discussion is to what extent will booking agents such as Webjet ((WEB)) and Flight Centre ((FLT)) be impacted? Expectations are equally low for traditional media companies.

Infrastructure owners are enjoying the benefits from cheaper funding costs, but assets might have been impacted by bushfires and other weather-related events. Utilities, as a group, are positioned for negative growth, while REITs look unspectacular, but solid (with lots of internal sector divergence).

A lot hinges on the sustainability of the current uptrend for property prices and the follow-on impact for construction activity in Australia. This not only feeds into optimism for retailers such as Harvey Norman ((HVN)), GWA Holdings ((GWA)) and Reece Australia ((REH)), but equally so for Super Retail ((SUL)), Autosports Group ((ASG)) and Automotive Holdings ((AHG)), as well as for the likes of Adelaide Brighton ((ABC)), Brickworks ((BKW)) and CSR ((CSR)), as well as Genworth Mortgage Insurance Australia ((GMA)).

Stockbroker Morgans has already expressed confidence in local specialty retailers, suggesting the environment for consumer spending is better than last year, which should allow the sector to release "OK" reports this month, despite a number of share prices having run already. Morgans' three sector Top Picks are Adairs ((ADH)), Baby Bunting ((BBN)), and Bapcor ((BAP)).

Shares in furniture retailer Nick Scali ((NCK)) were trading around $6 in November and they had lifted above $7 prior to Thursday's interim result release. The stock sprinted another 10.80% on the day of the release, as higher margins allowed for an earnings "beat".

Reductions in dividends are expected to be less of an issue, though a number of shareholders will still be disappointed. Cimic Group ((CIM)) already announced there will be no dividend this month after a large write-down from the abandoned operations in the Middle East.

Bulk commodity producers BHP Group ((BHP)), Rio Tinto ((RIO)) and Fortescue Metals ((FMG)) are all believed to be swimming in cash, offering ongoing potential for enlarged payouts to shareholders. Gold miners should be among beneficiaries as well.

Big miners seemed poised for a gold medal performance this month until the coronavirus appeared. Now the anticipated slowing in Chinese demand is putting a big question mark in front of the sector.

Renewed optimism has also descended upon engineers and contractors, though this sector in general remains beset with both hits and misses, as also proven by early profit warnings from Downer EDI ((DOW)) and Cimic Group.

Lastly, post unprecedented bushfires and Perpetual ((PPT)) acquiring an ESG investor in Boston, it is likely investors' focus will increasingly include questions about carbon footprint, risk from changing weather patterns, the modern slavery act, and the like.

Newcrest Mining ((NCM)) has already flagged further absence of rain will limit its production capabilities next year. Despite potential for an uptick in investment by energy producers, contractor Worley ((WOR)) has signaled appetite to diversify into green energy projects.

Confession season prior to February has seen a number of companies issuing profit warnings, including all three major general insurers and a number of retailers on top of eye-catching disappointments from the likes of Treasury Wine Estates ((TWE)) and Nearmap ((NEA)). Here the good news is the number of warnings this time around has been well below the numbers seen prior to February and August last year, further fueling the narrative things seem to be getting better/less bad, with further improvement to follow.

As the fallout from the East Coast bushfires continues to ring home, building repairer Johns Lyng Group ((JLG)) has announced itself as the first beneficiary from the rebuild post misery.

Hits & Misses: The Candidates

In terms of individual companies, analysts at UBS believe there is potential for upside surprises from BHP Group and Fortescue Metals, as well as from Charter Hall ((CHC)), Goodman Group ((GMG)), Dexus Property ((DXS)) and Mirvac Group ((MGR)).

The odds seem in favour of disappointing updates by the likes of Southern Cross Media ((SXL)), Seven West Media ((SWM)), HT&E ((HT1)), Domino's Pizza ((DMP)) and Inghams Group ((ING)), as well as from Scentre Group ((SCG)), Vicinity Centres ((VCX)), Lendlease ((LLC)), Flight Centre, Crown Resorts ((CWN)), and Star Entertainment ((SGR)).

UBS also believes expectations are likely too high for what CommBank ((CBA)) can possibly deliver this month. Small caps considered prime candidates for disappointment this month include Bega Cheese ((BGA)), InvoCare ((IVC)) and Japara Healthcare ((JHC)).

Small cap stocks likely to surprise, according to UBS, include Appen ((APX)), NRW Holdings ((NWH)), Webjet, and Flexigroup ((FXL)). The latter was kind of a favourite among analysts to be a likely winner this month, but the company issued a profit warning and so has become one of the early prominent disappointments. Just goes to show: there are no watertight certainties during reporting season.

Several analysts are expecting an excellent performance from Goodman Group, with some suggesting management looks poised to lift full-year guidance.

Macquarie finds upside potential rests with a2 Milk ((A2M)) while market consensus seems too high for Suncorp ((SUN)), Insurance Australia Group, and Medibank Private -all insurers!- as well as for South32 ((S32)) and Newcrest Mining.

JB Hi-Fi ((JBH)), often targeted during times like these through short positioning, is mentioned for its ability to deliver yet another strong result. Citi has high expectations for James Hardie ((JHX)), Coles ((COL)), and BlueScope Steel ((BSL)). The analysts contradict peers with positive forecasts for Shopping Centres Australasia ((SCP)), and with an ongoing negative outlook for Healius ((HLS)).

Other stocks mentioned with a negative bias include BWP Trust ((BWP)), Cleanaway Waste Management ((CWY)), OZ Minerals ((OZL)), Regis Resources ((RRL)), Qantas ((QAN)), Boral ((BLD)), Iluka Resources ((ILU)), Qube Holdings ((QUB)), Whitehaven Coal ((WHC)), Reece Australia, Adelaide Brighton, and Brickworks.

Stockbroker Morgans has also nominated Australian Finance Group ((AFG)), Infigen Energy ((IFN)), Telstra ((TLS)), Afterpay, QBE Insurance, Santos ((STO)), Generation Development ((GDG)), IDP Education ((IEL)), Mainstream Group ((MAI)), Pro Medicus ((PME)) and Megaport ((MP1)) for a positive surprise.

Additional prime candidates for a negative surprise according to the broker include AGL Energy ((AGL)), Spark Infrastructure ((SKI)), Link Administration ((LNK)), Bapcor, Apollo Tourism & Leisure ((ATL)), and Costa Group ((CGC)) while weaker outlook statements might be forthcoming from companies including Wesfarmers, AP Eagers ((APE)), Coronado Global Resources ((CRN)), Corporate Travel ((CTD)), National Tyre & Wheel ((NTD)), and AMP ((AMP)).

Earlier around mid-January Ord Minnett also pointed at Domain Holdings ((DHG)) for a potential upside surprise, alongside CSL, but the latter's share price has rallied strongly since.

I will be watching Amcor's ((AMC)) result closely on February 17. If that's a good one, it may finally allow the share price to break free from its post-Orora spin off stasis.

Follow FNArena's Monitor of Corporate Results via https://www.fnarena.com/index.php/reporting_season/

Part One of this week's Weekly Insights was published on the website on Thursday morning:

https://www.fnarena.com/index.php/2020/02/06/february-reports-global-uncertainties-profit-warnings-and/

Part Two was written on Thursday, 6 February 2020.

(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.)  

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to My Alerts (top bar of the website) and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website. 

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CHARTS

A2M ABC ADH AFG AGL AMC AMP APE APT APX ASG ATL BAP BBN BGA BHP BKW BLD BOQ BSL BWP CBA CGC CHC CIM COL CRN CSL CSR CTD CWN CWY DHG DMP DOW DXS FLT FMG FXL GDG GMA GMG GUD GWA HLS HT1 HVN IEL ILU ING IVC JBH JHC JHX JLG LLC LNK MAI MGR MP1 MPL NAB NCK NCM NEA NHF NTD NWH OZL PME PPT QAN QUB REA REH RIO RMD RRL S32 SCG SCP SGR SKI STO SUL SUN SWM SXL TLS TWE VCX WBC WEB WES WHC WOR WOW XRO

For more info SHARE ANALYSIS: A2M - A2 MILK COMPANY LIMITED

For more info SHARE ANALYSIS: ABC - ADBRI LIMITED

For more info SHARE ANALYSIS: ADH - ADAIRS LIMITED

For more info SHARE ANALYSIS: AFG - AUSTRALIAN FINANCE GROUP LIMITED

For more info SHARE ANALYSIS: AGL - AGL ENERGY LIMITED

For more info SHARE ANALYSIS: AMC - AMCOR PLC

For more info SHARE ANALYSIS: AMP - AMP LIMITED

For more info SHARE ANALYSIS: APE - EAGERS AUTOMOTIVE LIMITED

For more info SHARE ANALYSIS: APT - AFTERPAY LIMITED

For more info SHARE ANALYSIS: APX - APPEN LIMITED

For more info SHARE ANALYSIS: ASG - AUTOSPORTS GROUP LIMITED

For more info SHARE ANALYSIS: ATL - APOLLO TOURISM & LEISURE LIMITED

For more info SHARE ANALYSIS: BAP - BAPCOR LIMITED

For more info SHARE ANALYSIS: BBN - BABY BUNTING GROUP LIMITED

For more info SHARE ANALYSIS: BGA - BEGA CHEESE LIMITED

For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED

For more info SHARE ANALYSIS: BKW - BRICKWORKS LIMITED

For more info SHARE ANALYSIS: BLD - BORAL LIMITED

For more info SHARE ANALYSIS: BOQ - BANK OF QUEENSLAND LIMITED

For more info SHARE ANALYSIS: BSL - BLUESCOPE STEEL LIMITED

For more info SHARE ANALYSIS: BWP - BWP TRUST

For more info SHARE ANALYSIS: CBA - COMMONWEALTH BANK OF AUSTRALIA

For more info SHARE ANALYSIS: CGC - COSTA GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: CHC - CHARTER HALL GROUP

For more info SHARE ANALYSIS: CIM - CIMIC GROUP LIMITED

For more info SHARE ANALYSIS: COL - COLES GROUP LIMITED

For more info SHARE ANALYSIS: CRN - CORONADO GLOBAL RESOURCES INC

For more info SHARE ANALYSIS: CSL - CSL LIMITED

For more info SHARE ANALYSIS: CSR - CSR LIMITED

For more info SHARE ANALYSIS: CTD - CORPORATE TRAVEL MANAGEMENT LIMITED

For more info SHARE ANALYSIS: CWN - CROWN RESORTS LIMITED

For more info SHARE ANALYSIS: CWY - CLEANAWAY WASTE MANAGEMENT LIMITED

For more info SHARE ANALYSIS: DHG - DOMAIN HOLDINGS AUSTRALIA LIMITED

For more info SHARE ANALYSIS: DMP - DOMINO'S PIZZA ENTERPRISES LIMITED

For more info SHARE ANALYSIS: DOW - DOWNER EDI LIMITED

For more info SHARE ANALYSIS: DXS - DEXUS

For more info SHARE ANALYSIS: FLT - FLIGHT CENTRE TRAVEL GROUP LIMITED

For more info SHARE ANALYSIS: FMG - FORTESCUE METALS GROUP LIMITED

For more info SHARE ANALYSIS: FXL - Flexigroup

For more info SHARE ANALYSIS: GDG - GENERATION DEVELOPMENT GROUP LIMITED

For more info SHARE ANALYSIS: GMG - GOODMAN GROUP

For more info SHARE ANALYSIS: GUD - G.U.D. HOLDINGS LIMITED

For more info SHARE ANALYSIS: GWA - GWA GROUP LIMITED

For more info SHARE ANALYSIS: HLS - HEALIUS LIMITED

For more info SHARE ANALYSIS: HT1 - HT&E LIMITED

For more info SHARE ANALYSIS: HVN - HARVEY NORMAN HOLDINGS LIMITED

For more info SHARE ANALYSIS: IEL - IDP EDUCATION LIMITED

For more info SHARE ANALYSIS: ILU - ILUKA RESOURCES LIMITED

For more info SHARE ANALYSIS: ING - INGHAMS GROUP LIMITED

For more info SHARE ANALYSIS: IVC - INVOCARE LIMITED

For more info SHARE ANALYSIS: JBH - JB HI-FI LIMITED

For more info SHARE ANALYSIS: JHC - JAPARA HEALTHCARE LIMITED

For more info SHARE ANALYSIS: JHX - JAMES HARDIE INDUSTRIES PLC

For more info SHARE ANALYSIS: JLG - JOHNS LYNG GROUP LIMITED

For more info SHARE ANALYSIS: LLC - LENDLEASE GROUP

For more info SHARE ANALYSIS: LNK - LINK ADMINISTRATION HOLDINGS LIMITED

For more info SHARE ANALYSIS: MAI - MAINSTREAM GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: MGR - MIRVAC GROUP

For more info SHARE ANALYSIS: MP1 - MEGAPORT LIMITED

For more info SHARE ANALYSIS: MPL - MEDIBANK PRIVATE LIMITED

For more info SHARE ANALYSIS: NAB - NATIONAL AUSTRALIA BANK LIMITED

For more info SHARE ANALYSIS: NCK - NICK SCALI LIMITED

For more info SHARE ANALYSIS: NCM - NEWCREST MINING LIMITED

For more info SHARE ANALYSIS: NEA - NEARMAP LIMITED

For more info SHARE ANALYSIS: NHF - NIB HOLDINGS LIMITED

For more info SHARE ANALYSIS: NTD - NATIONAL TYRE & WHEEL LIMITED

For more info SHARE ANALYSIS: NWH - NRW HOLDINGS LIMITED

For more info SHARE ANALYSIS: OZL - OZ MINERALS LIMITED

For more info SHARE ANALYSIS: PME - PRO MEDICUS LIMITED

For more info SHARE ANALYSIS: PPT - PERPETUAL LIMITED

For more info SHARE ANALYSIS: QAN - QANTAS AIRWAYS LIMITED

For more info SHARE ANALYSIS: QUB - QUBE HOLDINGS LIMITED

For more info SHARE ANALYSIS: REA - REA GROUP LIMITED

For more info SHARE ANALYSIS: REH - REECE LIMITED

For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED

For more info SHARE ANALYSIS: RMD - RESMED INC

For more info SHARE ANALYSIS: RRL - REGIS RESOURCES LIMITED

For more info SHARE ANALYSIS: S32 - SOUTH32 LIMITED

For more info SHARE ANALYSIS: SCG - SCENTRE GROUP

For more info SHARE ANALYSIS: SGR - STAR ENTERTAINMENT GROUP LIMITED

For more info SHARE ANALYSIS: SKI - SPARK INFRASTRUCTURE GROUP

For more info SHARE ANALYSIS: STO - SANTOS LIMITED

For more info SHARE ANALYSIS: SUL - SUPER RETAIL GROUP LIMITED

For more info SHARE ANALYSIS: SUN - SUNCORP GROUP LIMITED

For more info SHARE ANALYSIS: SWM - SEVEN WEST MEDIA LIMITED

For more info SHARE ANALYSIS: SXL - SOUTHERN CROSS MEDIA GROUP LIMITED

For more info SHARE ANALYSIS: TLS - TELSTRA CORPORATION LIMITED

For more info SHARE ANALYSIS: TWE - TREASURY WINE ESTATES LIMITED

For more info SHARE ANALYSIS: VCX - VICINITY CENTRES

For more info SHARE ANALYSIS: WBC - WESTPAC BANKING CORPORATION

For more info SHARE ANALYSIS: WEB - WEBJET LIMITED

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For more info SHARE ANALYSIS: XRO - XERO LIMITED