Rudi's View | Feb 20 2020
This story features BREVILLE GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BRG
Dear time-poor reader: early insights from the February reporting season mix with an emerging international trend that should have every investors' attention
In this week's Weekly Insights:
-February Reports: The Green Divide Is Real
-No Weekly Insights Next Week
-Who's The Greatest In This Country?
-Get More Out Of Your Subscription
February Reports: The Green Divide Is Real
By Rudi Filapek-Vandyck, Editor FNArena
What a difference six months makes in the share market. It's still early days for the local corporate results season in Australia but a number of positive trends are vindicating the strong buying that supported equities in January:
-companies are finding it easier to meet or beat market expectations;
-earnings estimates last week made a trend change and are now rising instead of falling.
Of course, the cynics among us can counter-argue that market expectations leading into the February reporting season were rather low. This is true, but the same observation applied to the August season last year, and that turned out the worst reporting season post-GFC for corporate Australia.
Bottom line: things are improving, without getting too carried away, also helped by the fact investors are willing to take a supportive view, as long as the financial performance doesn't fall too much behind what should reasonably be expected.
One prominent victim this month appear to be speculators with short positions. Sharp rallies in share prices of companies including Breville Group ((BRG)), JB Hi-Fi ((JBH)) and Carsales ((CAR)), often well beyond upgraded valuations and price targets post the event, suggests shorters scrambling to reduce their losses has been one of the key characteristics during the opening two weeks of this reporting season.
When speculators take a short position on a stock, they are relying on future disappointment to depress the share price to their benefit. If, however, the share price rallies instead, it might open up the prospect for sizable losses, and thus those with a short position can turn into desperate buyers at all cost instead.
The Early Numbers
Early winners this season include Mineral Resources ((MIN)), IDP Education ((IEL)), Nick Scali ((NCK)), IPH Ltd ((IPH)), Challenger ((CGF)), the aforementioned Breville Group, JB Hi-Fi and Carsales, Magellan Financial ((MFG)), Pinnacle Investment ((PNI)), ResMed ((RMD)), Goodman Group ((GMG)), CommBank ((CBA)) and, yet again, CSL ((CSL)).
Amongst the early losers we can count Blackmores ((BKL)), Synlait Milk ((SM1)), Insurance Australia Group ((IAG)), Suncorp ((SUN)), Orora ((ORA)), Downer EDI ((DOW)), IGO ((IGO)), and Treasury Wine Estates ((TWE)), Cimic Group ((CIM)), and Nearmap ((NEA)) from the pre-season.
Multiple retailers and consumer-exposed stocks have surprised to the upside. So far, the report card for resources stocks and sector contractors has been rather mixed. Sector analysts at Bell Potter point out Decmil Group ((DCG)) also issued a profit warning pre-season, alongside Downer EDI and Cimic Group.
Don't be surprised to see more of the same from other peers this month, is their warning. Bell Potter agrees with analysts elsewhere the underlying trend is improving for the sector, on the back of increased spending by bulk miners and the energy sector, but short term plenty of potential exists for cost overruns on projects that were won through aggressive bidding over the past 12-24 months.
As can be read from FNArena's Corporate Results Monitor on Monday, 37.3% of corporate results (25) thus far has beaten expectations against 19.4% of released reports (13) that can be categorised as a clear "miss". This means more than 80% of the 67 reports recorded thus far has either met or bettered analysts' forecasts.
FNArena's Corporate Results Monitor: https://www.fnarena.com/index.php/reporting_season/
Two more important observations to point out are:
-the numbers look notably less attractive for Australia's large cap stocks. Scroll down when visiting FNArena's Monitor and you'll find the numbers for the ASX50 are 6 "beats" versus 5 "misses"; for the ASX200 this becomes 17 "beats" versus 11 "misses"
-hiding underneath these early statistics is the fact that when it comes to quality and pace of growth, leading international players are still outperforming domestically oriented peers, and this is again translating into "Quality" and "Growth" shares outperforming "Value" during the opening seven weeks of calendar 2020.
To put this in another way: companies whose share price has been carried by positive momentum pre-February have tended to release performances that are good enough to allow that positive momentum to continue. Analysts at Morgan Stanley have calculated the relative outperformance of such positive momentum stocks, no doubt including ResMed, CSL, Goodman Group and the likes, has risen to 15% since January 1st versus the value-laggards in the Australian share market.
Life is tough for investors who preferred the likes of "undervalued" Flight Centre ((FLT)), FlexiGroup ((FXL)) and Unibail-Rodamco-Westfield ((URW)) over, say, ResMed, CSL and Goodman Group. Even as many among the laggard stocks spike higher this season, including GUD Holdings ((GUD)), Bapcor ((BAP)), Pinnacle Investment, and the aforementioned selected retailers.
Clearly, expectations that a bounce in property prices across the main cities of Australia will have a positive impact on household spending have been proven correct. Though the jury is still out whether building materials and construction companies will become major beneficiaries too.
Meanwhile, the precise impact from the coronavirus on China and the rest of the world remains anyone's guess.
A few extra statistics from the equities desk at Goldman Sachs:
-the average stock post results release has outperformed the market by 1.5%
-companies that beat expectations saw their share price outperforming by 4.4% on average
-companies that missed expectations still saw their share price on average performing in-line with the broader market
In my preview ahead of the February reporting season, I suggested investors seemed prepared to wear rose-tinted glasses this season, and that last observation made by Goldman Sachs supports this view.
Sustainability No Longer A Phantom In Australia
Some investment experts have declared ESG investing –rules based on Environmental, Social and Governance principles– a defining new feature for the decade ahead, meaning investors are no longer in a position in which they can ignore these additional filters when making investment decisions, including in Australia.
Share market analysts at Morgan Stanley, for example, are predicting ESG is likely to grow into a secular, multi-year theme, comparable to TMT (telephony, media and technology) in the late nineties and FAANG in recent years (and the BRIC countries in between).
If correct, and taking guidance from past experiences, this implies this new emerging theme is still in its infancy and has many more years to develop. Morgan Stanley suggests these themes outperform for circa five years, while suggesting ESG as a defined share market theme is probably only 6-9 months old.
ESG started as predominantly a European phenomenon, but observers of US share markets have more recently witnessed it traveling across the Atlantic Ocean.
It would seem decarbonisation is the main focus for early ESG adopters, which benefits utilities in particular. No surprise thus quant analysts offshore have been observing a positive correlation between share prices in utilities and Quality and Growth stocks positively re-rating and trending upwards.
Conversely, increased attention for decarbonisation should negatively impact on fund flows into the energy sector.
On Morgan Stanley's assessment, positive re-ratings for European stocks including Alstom, Covestro, Kingspan, Neste and German utility RWE are at least partially driven by ESG and decarbonisation. They see similar observations emerging in US markets. Taking a positive view, the analysts suspect ESG Leaders might close the relative valuation gap with Quality and Growth in the years ahead.
In Australia, the 'Green' theme hasn't attracted much attention as yet, but I suspect this is because its impact mostly occurs through share prices unable to rally. In other words: to date ESG mostly impacts through what we don't see when we look at share prices; the likelihood that prices would have rallied higher and for longer under different circumstances.
For those who know what to look out for, ESG and decarbonisation are undeniably making their presence felt this reporting season in Australia. Below are some examples from the early wave of corporate reports:
–Amcor ((AMC)) – At face value, management at one of the world's leading packaging companies did many things investors usually like. The financial performance for the six months to December was not too far off from expectations and that large Bemis acquisition is being integrated smoothly, with more synergies to be achieved in the short term.
Management created for itself the opportunity to increase EPS growth guidance for FY20 to 7-10%. But the share price has moved lower since the release of interim financials, despite the fact the consensus price target post the event has lifted higher.
Hidden inside the finer details is downward pressure on rigid packaging with analysts now questioning whether demand for bottled water is coming under pressure across the globe. A move by Swiss consumer products giant Nestle to provide less details about its bottled water sales going forward seems to point in this direction.
Prior to last week's report, Amcor's share price had returned to where it was mid last year, after which global concerns about the future of plastic packaging weighed on the share price. It is possible this is more of a sentiment-related barrier, for now, with analysts covering the company convinced Amcor remains at the forefront of this industry's transition into a more sustainable modus operandi, but absolute certainty is not included.
Amcor has developed AmLite, which is being marketed as a "unique line of metal-free high barrier packaging that is recycable in markets where recycling streams exist". Critics counter-argue that while technically the 100% recyclability might be possible, it might take a long while yet until it is economically feasible.
It is a genuine possibility that Amcor shares, down less than -2% since the start of the year when the broader market has gained circa 6.5%, will continue to play catch up for longer while investors mull over a number of existential, longer-dated questions. In the meantime, the shares are offering 4.9% in prospective yield, on FY21 forecasts.
–Boral ((BLD)) – No doubt already one of the big disappointments this reporting season. Don't look, but Boral shares were trading at $7.74 two years ago, in January 2018. To say the acquisition of US-based Headwaters has cost shareholders dearly is quite the understatement.
Apart from fraud and accountancy irregularities, Headwaters also catapulted Boral into the North-American fly ash market, which looked interesting and potentially attractive at the time the acquisition was first announced. It has since dawned upon investors that coal fired power stations are in decline in the US, and this means management at Boral might have to revisit the numbers and projections for their North-American operation.
Fly ash is a by-product from the burning of coal used for its cementitious properties. Less burning of coal means less fly ash byproduct will be available in the future.
Without wanting to sound too dramatic about it, but could it be possible that Boral's acquisition of Headwaters might join the likes of Riversdale Mining by Rio Tinto in 2011 or CSR's ill-fated acquisitions of Pilkington and DMS glass businesses in 2007 and 2008? Both expansions cost shareholders dearly in the subsequent years.
According to the US EIA, US coal power generation declined -15% in 2019. A further -9% decline is expected for 2020.
–Bapcor ((BAP)) – The Bapcor logistics network of delivering car parts, predominantly to mechanics, has proved itself as one of the most resilient businesses listed on the ASX. Last week's interim report simply revealed more of the same. But that initial share price rally didn't last long, though the shares are still trading at a higher level than immediately prior to the results release.
A bit disappointing, really, considering analysts' targeted valuations are, without exception, all double digit percentages above today's share price.
I suspect, what is holding back the Bapcor share price is the persistent negative trend in new car sales, not just in Australia (22 consecutive months of negative sales growth) but across the globe. Businesses and consumers are increasingly preferring electric vehicles, though no accurate data are available in Australia. Apparently, Tesla, which is the market leader in this emerging new segment, does not share any sales data locally.
The big question on investors' mind is: how is this transition to electric vehicles going to impact on Bapcor's business and resilience post the medium term? In the meantime, management is adding an additional avenue of growth through accelerated investment in Taiwan.
Incidentally, a noticeable gap has opened up between how local insurers Suncorp ((SUN)) and Insurance Australia Group ((IAG)) view the emergence of autonomous vehicles. Suncorp thinks the speed of adoption is likely to surprise many in the decade ahead. IAG on the other hand, sees plenty of obstacles through legislation and infrastructure, to support its own view this transition will be rather slow and gradual.
Both insurers, of course, will be struggling to maintain business as usual if the recent bushfires on Australia's east coast are to become more of a regular feature in the decade ahead, alongside extreme temperatures and weather-related events in either direction.
Some other snippets with less direct impact in the short term:
–AGL Energy ((AGL)) reported insurance costs for coal assets continue to rise, also because such power stations seem to have more outages;
–Aurizon Holdings ((AZJ)), which derives some 40% of annual revenues from hauling thermal coal, has $525m worth of corporate bonds expiring in October. With lenders to its major coal customers facing heightened pressure to ditch thermal coal investments, investors' attention will be focused on how Aurizon's debt refinancing might proceed;
-As more companies globally are joining the goal to be carbon neutral, if not negative, by 2050, companies are rethinking travel plans for their C-suite and staff members. A recent executives survey by Credit Suisse revealed 63% of respondents are prepared to limit travels in order to achieve a more sustainable outcome.
Lastly, while positive beneficiaries from the increased focus on ESG, decarbonisation and sustainability mostly involves micro cap stocks on the Australian stock exchange, it should not be forgotten Macquarie Group ((MQG)) is one of the world's leading investors in the green theme.
Ahead of the curve, as always.
FNArena has been running a dedicated ESG news section since late 2018:
No Weekly Insights Next Week
No Weekly Insights next week as the local reporting season steps up a gear or two in the coming two weeks.
Before we move on to more things financial…
Our democracies are in danger. I know this sounds extremely hyperbolic, but it is not.
Since the middle of the twentieth century we have all become accustomed to the fact societies and political systems have become more open, accessible and accountable. In particular in the West, and in particular after the iron curtain collapsed in the late eighties.
Today we take too many things for granted. We assume bad history won't repeat. And just like the proverbial frog in gradually heating up water, we don't notice or even understand how the parliamentary system, the role of government, and its institutions are being undermined and eroded away. Read The Fifth Risk by Michael Lewis. Read Fascism, A Warning by Madeleine Albright.
There are, of course, many more authors, books and publications that can be read, but the message remains the same: undemocratic forces are on the rise, and they have the momentum on their side. Increasing limitations placed on free and independent media, of which FNArena is a proud member, is but one factor that is easy to identify.
Awareness is the first step to defending our democracies, who have never been flawless, but nevertheless far superior to any of the alternatives history shows us.
Who's The Greatest In This Country?
It wasn't that long ago that I stood upon my proverbial soapbox exclaiming the next decade will crown CSL ((CSL)) as the largest index constituent on the Australian share market.
Little did I know it could've happened last week already, if shares in CommBank ((CBA)) hadn't rallied 4% upon the release of interim financials.
For good measure, this doesn't make any of CSL or ComBank the largest company in Australia. That title stays with BHP Group ((BHP)), not for nothing referred to as the Big Australian. BHP shares a dual-listing with the bourse of London (UK) and those foreign listed equities do not count when Standard & Poor's compiles index weightings for the Australian share market.
So BHP remains Australia's largest company by market capitalisation, but when it comes to influencing the direction of local share market indices it doesn't reach further than spot number three. CommBank has been the local number one for a long time, well past a decade long, but the top position is increasingly being challenged by CSL.
I found the chart below in a recent research report by Morgan Stanley. I think it perfectly shows the stellar rise of CSL shares over the past two years, which, of course, followed upon a stellar rise over the decade(s) prior.
Let's cast our mind back to early 2018, with CSL shares similarly putting in a decent outperformance against both CBA and BHP shares, but it seemed such a long way off, still, before Australia's most successful biotech company would be able to challenge for the top spot.
All that has changed since, and rapidly too. As clearly shown on that chart, both BHP and CBA shares have merely trended sideways over the past two years, with CBA joining in the global rally in 2020, while CSL shares remain, clearly, in an uptrend. As said, if it wasn't for that strong rally on the back of CBA's interim report, CSL shares would by now be known as this country's heaviest index weight.
Now, unless one is a professional manager of funds whose performance is regularly compared with the index, what importance does all this have? Well, for starters, if you are an investor with a long term horizon, you might find it incredibly beneficial to have the trend working in the same direction as your portfolio's focus.
No matter what has been your entry level, your performance in relationship to the top three stocks in Australia would have always been better off by owning CSL rather than CBA, or, third choice, BHP.
But now that we've mentioned professional fund managers, I have been told a number of non-index followers have equally succumbed and now added CSL to the portfolio. Active managers have found it near impossible to outperform the local index in recent years, and calendar 2020 so far has been no exception.
Last year, the general excuse was that local tech darlings Altium, WiseTech Global and Afterpay were making all the difference, while, in fact, it was most likely the strong performance of CSL and Fortescue Metals that made the key difference. But with CSL shares approaching 8% of the ASX200, one can only imagine the Herculean task that seemingly awaits anyone who doesn't own the stock, and still has the ambition to outperform after management fees.
CSL shares rallied more than 13% in January alone, and they've added an additional $20 since. It's not difficult to imagine professional investors thinking there's only so much relative pain they can possibly bear. If you cannot beat them, you better join then. Their buying surely has extra-supported the CSL share price during the opening two months of the new calendar year.
Get More Out Of Your Subscription
About a decade ago, I once established FNArena was receiving close to 1000 emails a day during peak periods and no, there is not one zero too many in that number.
It goes without saying, we have since made some drastic changes to how and where we receive various emails. But the tsunami entering into inboxes can still be daunting at times.
And in between a press release from a company that isn't even listed in Australia and the necessary response from economists to the latest data release, somewhere sits the occasional email from one of our subscribers.
I do have a dedicated To Do folder for emails, but even that gets clogged up at times, especially when reporting season is taking up so much of our time, attention, and resources.
Since we launched our new website, now three years ago (can you believe it?), everyone with access to the website can leave a message via the messaging system we specifically developed to avoid all problems and inconveniences with emails. Most subscribers are by now aware of its existence, but too many are still sending in the occasional email.
I may not be able to respond immediately all the time, every time, but at least your email doesn't risk ending up unanswered, sitting somewhere deeply embedded in my To Do folder (or worse). So try it out, it works easily and fluently and whenever there's an answer waiting for you, the website will tell you upon next logon.
(This story was written on Monday 17th February 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
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