Feature Stories | Oct 02 2020
Download related file: FNArena-Reporting-Season-Monitor-August-2020
A comprehensive assessment of Australia’s corporate results in February and August 2020, amidst coronavirus pandemic and fall-out, economic disruption, more extreme central bank policies and ongoing tension between the world’s two super powers.
By Rudi Filapek-Vandyck, Editor FNArena
Ultimately, share markets are guided by corporate profits; more specifically by growth in profits, or by the threat to or absence of growth – whichever scenario applies in the moment.
FNArena has built up a reputation for dissecting and reviewing corporate results in Australia.
Usually, once a February or August season is finished, I put together a general overview of previews and intermediate assessments, to be revisited whenever handy in the future, but this year in mid-February all attention went to the spreading global pandemic, and very little else.
Which is why, post August, we’re doing things differently by combining all commentary and analysis on both reporting seasons in one 2020 overview. In reverse chronological order.
The initial idea was to combine all three Monitors (February, August plus in between) in one document, but that idea was scuppered by technical limitations as it would create too big a file to download. Hence, only the August Monitor in PDF is attached. For the two other reporting seasons, paying subscribers can visit FNArena's Corporate Results Monitor at https://www.fnarena.com/index.php/reporting_season/ – look for the archive going back to August 2013.
In addition, we already published the Wrap in early September: https://www.fnarena.com/index.php/2020/09/09/august-2020-result-season-the-wrap/
Stats, Damn Lies, And Corporate Profits?
One of the under-reported observations from the recent August reporting season is the ever-widening gap between statutory profits and “underlying” profits, with the latter increasingly being promoted by ASX-listed businesses as the true marker of overall performance.
It goes without saying, there can be multiple, valid reasons why companies switch to underlying profits, and it does not by default indicate fraud or deception is now high on the agenda.
But on calculations published by the AFR’s James Thomson on 31 August, the gap between statutory and underlying profits has grown as wide as $28.6bn -76.5%- for the 172 members of the ASX200 that reported during the month.
$37.3bn versus $65.8bn “underlying” – it’s hard to fathom this is not an all-time record and surely it must act as a warning to shareholders that more scrutiny might be required during times of corona and lockdowns.
Within this framework, ASIC last week reported it had intervened in four cases of financial reporting by four local companies.
These four in question are (with quotes from the official ASIC communication):
-Nitro Software Limited ((NTO)) – The decision to reduce both its contract assets and deferred revenue balances relating to client software subscriptions by $14.7 million in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns on the recognition of the equal and offsetting contract assets and deferred revenue from the inception of multi-year subscription contracts at 31 December 2019.
–Kresta Holdings Limited – The decision to reduce the gain recognised on a sale and leaseback transaction by $997,000 in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns on the amount of the gain on the sale and leaseback of a property under a new standard on lease accounting in the financial report for the year ended 31 December 2019.
-Elixinol Global Limited ((EXL)) – The decision to impair goodwill, inventories and other assets by $60 million in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns about the reasonableness and supportability of free cash flow forecasts used in assessing goodwill for impairment at 31 December 2019 having regard to historical performance and market conditions.
–LawFinance Limited ((LAW)) – The decisions to reclassify $41.6 million of liabilities from non-current to current and to restate comparative information to recognise $19.6 million of fair value gains on liabilities in the following period in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns on the classification of liabilities and recognition of fair value gains on liabilities in the financial report for the year ended 31 December 2019.
According to Thomson’s analysis, by far the largest contributor to the gap between statutory and underlying profits came from asset write-downs by the likes of Boral, Qantas and Woodside Petroleum.
August 2020 Lifts Price Targets
For securities analysts, each reporting season offers a welcome update on how companies are faring operationally, and this includes contracts, investments and sales, as well as margins, inventories and cash flows.
Within this framework, market forecasts had never looked as wide and as diverse as post-February, so the August reporting season has been more than just welcome, with widely diverging forecasts in many cases rejoining around a much more feasible middle ground.
For many an investor/shareholder, this background re-adjusting of modeling and forecasts is often largely ignored, even though paying attention can provide clues about future sentiment towards and the direction of a share price.
Not every investor is convinced these analysts are worth every cent they are being paid, but fact remains: upward and downward adjustments to forecasts act like a magnet on share prices, sometimes even on what looks like rather small changes.
One of the easiest accessible indicators for what is happening behind the scenes of daily volatile market moves are consensus price targets for individual stocks.
In essence, these targets symbolise the general idea of where analysts think the share price should be, roughly, incorporating current information and with all else remaining equal.
As I have pointed out numerous times over the years, share prices often tend to converge with these targets, unless there are other factors in play that weigh on investors’ sentiment.
[Special Note: the FNArena service includes The Icarus Signal, which signals when share prices are above or very close to consensus targets, though investors should always include context and their own insights and observations when taking guidance from such a broad-based, generalising, automated tool.]
Hence, every reporting season one of the key indicators I look at is what happens to price targets once companies have publicly disseminated and discussed their financial performance, and analysts have digested the numbers, and put fresh insights through their now updated modeling.
In simple terms: when targets move higher, it’s probably because forecasts have gone up, and this usually means the share price will rise.
If the above coincides with a positive “surprise” (otherwise known as an earnings beat) and the share price is nowhere near the new targets, then you can almost be assured the share price is now being carried further by ongoing positive momentum.
Such momentum carries into general sentiment, and before you know it, we’re talking multiple weeks, if not months of additional gains.
The opposite holds true as well. Irrespective of whether a financial result met forecasts or not, if the outcome post-release is falling expectations and a reduction in valuations and targets, chances are very much in favour of persisting downward pressure on the share price.
As happens in every reporting season, August offered plenty of examples for each of these scenarios.
AGL Energy ((AGL)) surprised most with a downbeat guidance and the consensus target for the stock tumbled to $14.84 from $16.45 prior to the FY20 release.
In response, the AGL share price quickly reset around $15 from $17-$18 before the market update.
The AGL board promised to pay out 100% of cash earnings to shareholders in the next two years, but this hasn’t prevented analysts from putting the knife in their forecasts, assuming near 100% payouts in FY21 and FY22, but ultimately forecasting a lower dividend in two years’ time.
The reset in profit forecasts is clearly visible on the bottom part of the share price graph that can be found via Stock Analysis on the website, idem for the reduction in consensus target.
The same basic principle applies to similarly underwhelming market updates released by companies such as Bendigo and Adelaide Bank ((BEN)), Blackmores ((BKL)), Challenger ((CGF)), Cimic Group ((CIM)), GWA Group ((GWA)), InvoCare ((IVC)), Japara Healthcare ((JHC)), Mayne Pharma ((MYX)), Origin Energy ((ORG)), Seek ((SEK)), Telstra ((TLS)), and Seven West Media ((SWM)).
In all of these examples, price targets have fallen post the release of financials, and in all cases the share price has not even made a half-hearted attempt since to close that glaring gap between share price and target.
Data-analysis from past reporting seasons in Australia has shown share prices post earnings disappointment are poised for persistent underperformance that can last three months, at times even longer.
I haven’t done any broad analysis regarding falling forecasts and price targets and their effect on share prices, but anecdotal observations suggest these are the kind of stocks that are, for the time being, likely to remain deprived from any sustainable upward momentum.
Until things turn around, which can take a while.
It goes without saying, each reporting season has plenty of examples of companies outperforming expectations, forcing analysts to lift forecasts, which usually pushes up price targets, providing ongoing momentum to already rising share prices.
August saw plenty of such events with, on FNArena’s calculations, the average gain for price targets during the month climbing to 6.49%. All price targets in aggregate rose by 5% (net) over the month.
Considering that profit forecasts went down to -20% for FY20, and they fell a little further (net) throughout the season, those target data easily explain as to why August 2020 turned into a positive experience for Australian investors.
The key insight, however, is that these numbers are predominantly generated outside of the ASX50. Consider the following:
–For the ASX50 (44 companies)
-Total Beats: 11 (25%)
-Total Misses 12 (27.3%)
-Average increase in individual price target: 1.67%
-Total increase in aggregate price targets: 3.14%
Now consider the total stats for 318 companies recorded for the season (which also includes the ASX50):
-Total Beats: 114 (35.8%)
-Total Misses 61 (19.2%)
-Average increase in individual price target: 6.49%
-Total increase in aggregate price targets: 5%
If there is still anyone out there who questions as to why there is such a wide gap between winners and losers in the share market, and why the Australian share market finds it nigh impossible to keep up with the US in this bull market, or why so many investors instinctively are drawn to smaller cap companies when looking for the next opportunity, I think the above numbers tell all.
Some of the eye-catching, stand-out performances last month, with price targets literally jumping into a higher dimension, came from Adairs ((ADH)), Afterpay ((APT)), Ansell ((ANN)), ARB Corp ((ARB)), AUB Group ((AUB)), Australian Vintage ((AVG)), Austal ((ASB)), Autosports Group ((ASG)), Aventus Group ((AVN)),.. I am still only at the first letter of the alphabet while going through the final conclusions of the FNArena Results Monitor for August…
If you are an FNArena subscriber, my message to you is: we built this easily accessible tool. It’s available 24/7 on the website. Use it. (There is an archive too going back to August 2013).
The more intriguing cases are those where forecasts & targets and the share price have moved in opposite directions. Similar to the examples mentioned above: it all comes down to specific strategies and horizons, and to personal knowledge and convictions.
Appen’s ((APX)) FY20 result was not well-received and it certainly did not help that the release was preceded by a rally in the share price to $44 from $36 (so much for the market knows best, n’est-ce pas?)
Fact remains, while the share price got clobbered post event, the average target actually went up; to $37.75 from $34.58.
Admittedly, opinions among analysts covering the company have become more polarised and nothing is ever without risk, but I am siding with the optimists: there still is so much growth ahead of this company, and that is what will ultimately drive the share price.
Appen remains part of the FNArena-Vested Equities All-Weather Model Portfolio and we have used this weakness to buy additional shares, as we did with ResMed ((RMD)).
In similar vein, Nanosonics ((NAN)), MNF Group ((MNF)) and APA Group ((APA)) all sold off post results release – see last week’s Weekly Insights.
Not every share price that falls represents an equally attractive investment opportunity, but when analysts are adding to their valuation it’s good to remember that if these valuations stand their ground, the share price will follow, eventually.
Stock Ideas & Conviction Calls
Some statistics from the research department at Macquarie:
-Earnings per share (EPS) fell by -20%, an outcome on par with the GFC, says the broker (Others have estimates falling by between -17.5%-22%)
-Earnings beats were primarily driven by small caps and new economy companies
-Macquarie’s buy ideas from the August season, included in the strategy portfolio, are Charter Hall ((CHC)), Amcor ((AMC)), Worley ((WOR)), Fortescue Metals ((FMG)), BHP Group ((BHP)), Crown Resorts ((CWN)), Sydney Airport ((SYD)), Ramsay Health Care ((RHC)), Telstra, and Oil Search ((OSH))
-Maquarie’s EPS growth forecasts are for 4.8% in FY21 -driven by iron ore- and 11% in FY22
-Macquarie has singled out two covid-19 beneficiaries that seem destined for underperformance: ResMed and Ansell
-Investors looking to rotate into covid-19 losers should consider Crown Resorts, Star Entertainment ((SGR)), Sydney Airport, Qantas ((QAN)), Cochlear ((COH)), and IDP Education ((IEL))
-Value opportunities to consider include Qantas, BlueScope Steel ((BSL)), Challenger, Telstra, Oil Search, Stockland ((SGP)), Link Administration ((LNK)), nib Holdings ((NHF)), Transurban ((TCL)), BHP Group, Lendlease ((LLC)), Ramsay Health Care
-Stocks to avoid, Macquarie suggests, include Hub24 ((HUB)), Netwealth Group ((NWL)), Ansell, and Newcrest Mining ((NCM))
-Potential value traps, according to Macquarie: Bendigo and Adelaide Bank, Alumina Ltd ((AWC)), InvoCare, Whitehaven Coal ((WHC)), and CommBank ((CBA)) – I bet you haven’t seen the latter being called a value trap, possibly ever!
Some additions from stockbroker Morgans:
-50% of companies that reported FY20 earnings are forecast to return to FY19 numbers in FY21 (pretty good, considering)
-In general terms, market earnings in Australia are forecast to recover to FY19 levels by 2022
-In this context Morgans finds the local market’s 17x FY22 profit forecast “passable” on the proviso investors remain happy to look through the two years' earnings dip and wear associated risks to the economic recovery
-Dividend payers considered well-placed to weather the risks, include Aurizon Holdings ((AZJ)), APA Group, Centuria Industrial REIT ((CIP)), Iress ((IRE)), IPH Ltd ((IPH)), and Waypoint REIT
UBS made the point that heavily shorted stocks were among major market outperformers in August.
Sze Chuah, senior investment strategist at Ord Minnett, has equally made a number of changes post reporting season.
Ord Minnett has identified five themes for investors to incorporate in their strategies and portfolios; four positive and one negative.
Theme 1: Reopening and recovery
Preferred exposures include National Australia Bank ((NAB)), Origin Energy, Star Entertainment, and Sealink Travel Group ((SLK))
Theme 2: Flight to quality
Here Ord Minnett’s assessment of “quality” is clearly different from mine (in some cases). Preferred exposures are Amcor, APA Group, Coca-Cola Amatil ((CCL)), Coles ((COL)), GPT Group ((GPT)), Rio Tinto ((RIO)), and Sonic Healthcare ((SHL))
Theme 3: Dividend defenders (low chance of having to cut)
Preferred exposures: AusNet Services ((AST)), Charter Hal Long WALE REIT ((CLW)), Perpetual ((PPT)), Service Stream ((SSM)), and Waypoint REIT ((WPR))
Theme 4: Policy tailwinds (companies that rely less on economic conditions)
Suggested exposures: Clover Corp ((CLV)), Cleanaway Waste Management ((CLW)), Hub24, and Lynas Corp ((LYC))
Theme 5: Risky Business (best to avoid)
Here Sze has removed Flight Centre ((FLT)) and TechnologyOne ((TNE)), both following share price weakness.
Remain on the avoid list: Computershare ((CPU)), Northern Star ((NST)), Goodman Group ((GMG)), Tabcorp Holdings ((TAH)), and Treasury Wine Estates ((TWE)).
Small Cap specialists at UBS have updated their list of most preferred stocks, now including Eagers Automotive ((APE)), Appen, Bapcor ((BAP)), Breville Group ((BRG)), Collins Foods ((CKF)), EclipX Group ((ECX)), Graincorp ((GNC)), Harvey Norman ((HVN)), IDP Education, NRW Holdings ((NWH)), NextDC ((NXT)), and United Malt Group ((UMG)).
UBS’s key sell recommendation remains TechnologyOne, with the analysts suggesting while this remains a high quality business, risks are building short term from covid-19 interruptions and a potentially slower migration to SaaS by clients.
The team has also lined up a list of “laggards” that could well turn into winners over the next six months: Webjet ((WEB)), G8 Education ((GEM)), Servcorp ((SRV)), Flexigroup ((FXL)), Audinate Group ((AD8)), Corporate Travel Management ((CTD)), Bingo Industries ((BIN)), and AMA Group ((AMA)).
Their peers at JP Morgan have elevated Superloop ((SLC)) to be their Top Pick, while Flight Centre is Bottom Pick.
Strategists at Morgans see the biggest potential for upside surprise from here onwards with companies higher leveraged to economic activity and currently held back by low expectations. Think sectors like Travel, Gaming, Energy, and Commercial Services.
Key stock ideas post August are divided over four baskets:
Westpac ((WBC)), BHP Group, Rio Tinto, Macquarie Group ((MQG)), Amcor, Aurizon Holdings, Coles
-ResMed, Aristocrat Leisure ((ALL)), NextDC, Breville Group, Hub24
-Sydney Airport, Corporate Travel Management, ALS Ltd ((ALQ)), Aventus Group ((AVN)), Santos ((STO)), Beach Energy ((BPT)), Eagers Automotive, Incitec Pivot ((IPL))
-APA Group, APN Convenience Retail REIT ((AQR)), and Waypoint REIT
Morgans also retains a positive view towards retailers, with the strong sales momentum experienced by many leading into August expected to remain firm at least until the start of 2021.
Morgans argues retailers face two large risks: societies opening up quicker, or government support being withdrawn.
Preferential ideas leading into AGM season include Adairs, Accent Group ((AX1)), Baby Bunting ((BBN)), Domino’s Pizza ((DMP)), and Super Retail ((SUL)).
Following August, and a strong rally for many retailers, Morgans’ sector preference lays with Adairs, Eagers Automotive, Breville Group and Super Retail.
The broker prefers a cheaper entry point for Baby Bunting, and is willing to be patient with Lovisa Holdings ((LOV)).
Market strategists at Wilsons stick with their Quality and Growth bias, but have nevertheless decided it’s best to add more cyclicality to their Australian Focus List portfolio, as positive vaccine news can potentially change market dynamics instantly and dramatically.
Wilsons added Reliance Worldwide ((RWC)), while also adding to exposure to BHP Group, Seven Group Holdings, Santos, and News Corp ((NWS)).
Equally remarkable, Wilsons has decided to remain Overweight the local healthcare sector and has reduced the weighting of CSL ((CSL)) but increased exposure to ResMed.
Strategists at Citi highlight the point the division between higher valued and lower valued stocks is, essentially, a division between those who have growth, and are expected to continue to grow, and those who don’t have it.
Sectors expected to continue growing earnings over FY19-FY22 are healthcare, food & beverages, retailing and technology.
With exception of food & beverages, these are the sectors that outperformed throughout August, further underpinning Citi’s analysis.
Value investors should be aware that if current market expectations continue to be met, the same growth companies should continue to outperform the market laggards, where growth remains absent, suggests Citi.
As such, the analysts observe sectors that offer growth outperform, irrespective of downgrades to forecasts.
Which then leads to the following statement: “Until COVID-19 distortions to economies begin to fade, companies with earnings growth should continue to outperform and widen the valuation divide.”
Citi’s forecasts are more subdued for FY21, with a much bigger growth recovery projected for FY22 (16.9%). The difference for FY21 seems to be in Resources, which suggests a different view on iron ore, or simply one catch-up short that still needs to happen.
This doesn’t negate the fact that, as forecasts stand post August, the big focal point for today’s value & laggard stocks, and the Australian share market in general, is FY22, not the year ahead.
Citi strategists in the US also believe today’s elevated valuations for the top leaders on the US stock market are similar to the bubble-alike valuations back in 2000, when measured by backward looking data and corrected for the much lower taxes being paid today.
While fully well realising how contentious this type of analysis/conclusions are, the strategists do acknowledge the fact such valuations were more broad-based back then.
Peter Warnes, head of equities research at Morningstar, believes Trump will win the November 3 election in the US.
August 2020 Fits The Post-2013 Narrative
As we leave August 2020 behind us, dominated by a domestic reporting season that on multiple levels proved better-than-feared, it is my personal observation that investors in Australia now can be clearly divided in two opposing groups:
-those who are elated and chuffed as exposure to the sharp rebound in equities has paid off in spades, or at least it has seriously mitigated the losses incurred earlier in the year;
-those who feel deeply frustrated as most of their money is not in the share market, or it is in equities that have not fully participated in the strong recovery off the late-March low.
Probably the stock that illustrates the 2020 share market narrative the best in Australia is Afterpay ((APT)), a local payments facilitator that only started life as a publicly listed company in mid-2017.
Who could ever have imagined that a little over three years later, this company is now the global leader in a newly emerging online segment of the global payment processing industry, one that now has everybody’s attention, with Afterpay’s market capitalisation rallying into the local Top20?
The Afterpay story is two-fold: on the one hand we have an increasing number of newly listed technology disruptors who start from humble beginnings but potentially have a great future ahead of them.
On the other hand, the covid-19 pandemic and global lockdowns have pushed newly emerging societal shifts and trends into acceleration, with the unexpected result there are companies and business models out there that are not just benefiting, they are thriving.
When I met up with an old mate of mine recently, who’s a mortgage broker, I was perplexed to hear many of his customers who run a café or restaurant are, post the initial scare from lockdowns, currently experiencing extreme boom-time conditions.
Lockdowns are bad news. The human instinct is to focus on the sad stories that emerge. Many cafes and restaurants in my neighbourhood are still closed, or have vacated the premises.
But those re-opening in the right place and with the right adjustments and operational costs are meeting huge pent-up demand.
Every crisis shares that same common core characteristic: the strong will become stronger.
This time around, the global pandemic has created a separate group of “lucky winners”, so to speak, and their growth potential has been turbo-charged.
Afterpay might be among the few truly lucky ones on the ASX that are enjoying two firm, beneficial shifts driving their business and the share price, they are certainly not the only one.
In many ways, the Afterpay story is not dissimilar from NextDC’s ((NXT)), or from Xero’s ((XRO)), or from Carsales’ ((CAR)), and a number of others.
Not every sustainable growth story listed on the ASX is equally witnessing their customers’ spending going ballistic, but if they are truly carried by market leadership, a defendable moat, a commercial advantage, and they are not weighed down by too much debt, an inability to amend or cut costs, or by delusional or bad management, they will come out stronger, if they haven’t already.
Short-term threats and issues aside, beneath the surface of daily moving share prices, the dominating narrative of successful investing in the share market has not changed since 2013: it’s about finding growth, and sticking by it.
You certainly wouldn’t want to bet against it.
Goodman Group ((GMG)) just beat its own guidance, yet again, for the ninth time in succession. Nick Scali ((NCK)) has guided for 60% growth in net profit this half to December.
ARB Corp’s ((ARB)) order book is at an all-time record high.
NextDC’s quintessential dilemma is that demand growth for data centres is so strong, it may potentially run out of capacity before the next phase of expansion becomes available.
Of course, for long term investors as opposed to shorter-term momentum followers, the crucial question is the longevity of it all. Reading through analysts’ research reports in August, this is equally front of mind for those who need to put a value and a recommendation on these stocks.
Most question marks involve retailers currently shooting the lights out.
As strong and solid as the companies above, and many more others, stood out with their financial performances in August, for plenty of others what comes naturally to the few remains too hard to accomplish or to maintain.
Shares in AMP ((AMP)) might look undervalued, and they have been for quite a while, but the company again disappointed in August, while attracting lots of media coverage for all the wrong reasons.
If ever a company on the local bourse has provided plenty of evidence that paying attention to corporate culture, and to ESG (Environmental, Social and Governance criteria) in general is not a luxury but essential, it would have to be AMP.
I also believe it is companies like AMP that are teaching your typical “value” investor some incredibly harsh lessons, causing immense frustration for much longer.
Other examples from the same basket of “simply offering too much attraction to resist”, but proving frustrating duds instead, include (in no particular order) Boral ((BLD)), Unibail-Rodamco-Westfield ((URW)), Ainsworth Game Technology ((AGI)), Bendigo and Adelaide Bank ((BEN)), Challenger ((CGF)), and yes, let’s throw Telstra ((TLS)) in the mix as well.
Let’s call a spade a spade: shares in growth companies might temporarily get a bit hot under the collar, but they are still multiple times a better investment than cheap looking stocks that cannot deliver the bare essential, which is growth.
One special mention goes out to Whitehaven Coal ((WHC)) whose share price got clobbered upon realisation that if coal prices stay at current low level for much longer, this company will receive that dreaded phone call from its lenders.
This is not to say the company is facing insolvency or the board might have to call in administrators, but a fresh equity raising (at a serious discount) will definitely become a real possibility – and that’s what the market has now quickly priced in.
Another special mention has to be made for the local aged care providers, with all of Regis Healthcare ((REG)), Estia Health ((EHE)) and Japara Healthcare ((JHC)) yet again being exposed as underfunded, low quality, struggling operators in a sector that has not necessarily seen the final piece of bad news just yet.
As well, while share price responses throughout August have been mostly positive, see also CommSec data further below, investors better not lose sight of what has been the main story in share markets for the past few years: gains achieved by new competitors and disruptors are creating headwinds for under-fire incumbents.
Analysts at Citi, on Monday, argued the case that strong momentum for the likes of Sportsbet and BetEasy, where top line and margins are almost literally flying higher as Australian punters are moving online, stand in sharp contrast with declining revenues at Tabcorp Holdings ((TAH)).
While optimistic shareholders in Tabcorp might argue bricks and mortar venues will re-open at some point, Citi points out Sportsbet in particular is spending hard and fast to pamper these new clients in an attempt to make them stick.
Tabcorp is equally one of the larger cap stories on the ASX that has provided mostly frustration for investors who thought they were buying into an attractive, cheap looking valuation, with an attractive looking yield.
The share price remains well, well below the pre-covid level, and prior to the sell-off in February those shares had range-traded for five years!
Citi thinks Tabcorp is still only half way to a more sustainable outlook, post capital raising and that badly needed cut to the payout ratio. Current yield 2.2% on FY21 consensus forecasts.
The broker suggests the incoming CEO needs to reset the wagering business and exit gaming services in order to pull this moribund elephant back onto a sustainable growth path.
The story for all of these, and many other companies remains the same: today’s cheap looking share price can only move sustainably higher if and when the successful turnaround arrives, and that means: growth, where art thou?
Australian bank shares, with notable exception of CommBank ((CBA)), are still circa -25% below pre-covid prices.
In similar vein as for others in that “cheap but frustrating” basket of stocks, UBS banking analysts concluded on Monday it’s best investors retain a cautious approach to the sector.
For Australian banks to shake off their current book value discount, UBS suggests the following stepping stones need to fall into place:
-we need to see ongoing reduction in virus cases, preferably with positive news about a vaccine
-economic data needs to continue to improve
-the bond market’s yield curve (difference between short term and long term bonds) needs to steepen materially
Of course, there are many more ways for companies and business models under pressure to try to turn around that sagging, moribund momentum.
Long-time struggling telecom reseller amaysim Australia ((AYS)) is now selling its energy customers grouped together under the brand of Click Energy to equally struggling energy retailer AGL Energy ((AGL)).
And that other prime example of bad corporate culture and negative ESG scores, IOOF Holdings ((IFL)) is buying struggling MLC off under-pressure National Australia Bank ((NAB)).
August provided many more examples, both successful and unsuccessful, and investors will be hoping the buyers can get as much (lasting) benefit out of these transactions as the sellers think they do.
Companies that are still looking to sell include BHP Group ((BHP)), Downer EDI ((DOW)), Lendlease ((LLC)), and Oil Search ((OSH)).
With August now done and dusted, FNArena will soon have its final statistics for the season ready, but one observation is easily made: this has been one of the best reporting seasons in a long, long while.
On CommSec’s data analysis, 53% of ASX200 companies that reported results saw a lift in share prices on the day of earnings release with an average gain of 0.7% and a gain of 0.8% after two days.
Big gainers include WiseTech Global ((WTC)), IDP Education ((IEL)) and Monadelphous ((MND)) while on the receiving end some of the stand-out punishments were delivered to Whitehaven Coal, Bravura Solutions ((BVS)), Nanosonics ((NAN)), and Appen ((APX)).
Despite persistent weakness towards the end of the month, mostly on macro factors including the strong Australian dollar, the local market rose an additional 2.2% over the season.
It got pretty volatile, in particular during the final week, but all in all the undercurrent remained positive.
Of course, the broader context is investors have been hit hard with dividend cuts and many share prices that have not recovered from the February-March mayhem, but companies have shown they still know how to cut costs, and hence beat market expectations.
Irrespective, investors must bear in mind August turned into a positive experience because analysts’ forecasts were too low, not because corporate Australia has been shooting the lights out.
A lack of quantitative guidance for the year ahead by companies remains a dominant feature.
On CommSec’s numbers, of all companies reporting a profit for FY20, only 48% managed to report growth, with 52% reporting a decline.
Adding all profit reports up for the season, CommSec concludes aggregate earnings were down -38% on a year ago, which in itself was not a great reporting season.
All revenues combined went up by 3.4%, but total expenses rose by 4.1% also because covid-19 required extra measurements, see for example the updates released by Coles ((COL)) and Woolworths ((WOW)).
The major pain point, of course, was in dividends.
Even though plenty of companies surprised by unexpectedly paying out a dividend, or a higher dividend, the fact remains, in aggregate, total dividends paid out by Australian companies declined by -36%.
Looking back over the six months to December 2019 (interim results), CommSec reports just over 87% of the ASX200 companies issued a dividend. But for the full year to June 2020, only 69% of companies have elected to pay a cash return to shareholders.
The average over the past 20 reporting seasons stands at 86%.
Still on CommSec data, almost 23% of companies lifted dividends; 12% held dividends steady; 53% of companies reduced dividends or didn’t pay a dividend; and 12% of companies that didn’t pay a dividend last time (in February) also didn’t pay a dividend this time.
Of those trimming dividends, 20% of all companies or 27 companies that paid a dividend last time indicated they won’t be paying a final dividend. And 47 companies (34%) paid a reduced dividend.
Of the 94 companies paying a dividend, 33% lifted dividends; 17% kept the payout steady; and 50% reduced the dividend.
There’s plenty of ongoing uncertainty, but also plenty of ongoing support from governments and central banks, leading CommSec to predict the All Ordinaries is likely to remain in a range of 6,350-6,750 by end-2020, with the range for the ASX200 between 6,200-6,600.
Investors might also pay attention to Citi strategists who this week reported Citi’s market sentiment gauge, the Panic-Euphoria Model, has surged firmly into euphoria territory.
As a matter of fact, Citi’s reading of market sentiment hasn’t been this high since early 2001, leading the strategists to warn that, historically, this translates into a 100% probability that share markets are due for a downward correction.
As per always, the exact timing is not yet known.
The FNArena-Vested Equities All-Weather Model Portfolio still hasn’t been enticed into buying shares in Afterpay, but the portfolio has plenty of quality and sustainable growth stocks to keep the performance up.
On my observation from running this portfolio for more than 5.5 years, the portfolio has had mostly positive experiences during each of the February and August reporting seasons, in line with the general observations described earlier.
The portfolio re-allocated some funds into quality, sustainable dividend payers post results in August, and the choice was made to add APA Group ((APA)), Charter Hall Long WALE REIT ((CLW)), and Aventus Group ((AVN)).
We also used share price weakness to add Nanosonics ((NAN)) and MNF Group ((MNF)).
All in all, the Portfolio gained 2.99% over the month, which was slightly better than the ASX200 Accumulation Index at circa 2.7%.
Year to date, since January 1st, the All-Weather Portfolio is up 2.58% whereas the ASX200 Accumulation index is still more than -7% in the negative.
August Reporting Favours Quality & Growth
One observation that has caught my attention is that as times have become tougher for corporate Australia, more companies have decided to release financial results later in the season.
A quick run through recent years’ reporting seasons has revealed that by this time in August 2018, the FNArena Corporate Results Monitor contained some 70 companies more than it does this year.
These companies will still be reporting, of course, so expect a tsunami in catch-up financial results releases during the final days of August.
On multiple observations and measurements, reporting seasons in Australia worsened considerably after August 2018 (if we only concentrate on the February and the August seasons).
No surprise, the balance as to when companies schedule for financial results releases has noticeably shifted towards the final two weeks of each season.
Having noted the above, August 2020 has been, all things considered, surprisingly positive thus far.
If current trends hold up for the remaining 140 or so corporate results, then August 2020 will mark a return to the good old days pre-2019; when Australian companies mostly met or beat expectations, and analysts lifted valuations and price targets higher in response.
[Paying subscribers can access the archive for Corporate Results Monitors on the FNArena website tracing back to August 2013].
Thanks to detailed data analysis from JPMorgan, we can now also confirm reporting seasons in Australia are becoming more volatile with sharper price movements occurring in either direction.
Of course, every reporting season generates negative and positive surprises, and share prices tend to reflect this, all else remaining equal. But JPMorgan’s analysis clearly shows share prices, on average, respond through bigger moves nowadays and the number of sharp moves remains in an uptrend too.
Underlying all of this, remains a wide dispersion between “winners” and “losers” -quality and growth versus lagging value- and post February, a new kind of demarcation has sprung to life as the covid-19 pandemic has created its own set of “winners” and “losers”; virus beneficiaries versus victims.
With uncertainty high and only few companies willing (and able) to provide positive guidance for the year ahead, investors have proved remarkably forgiving in their treatment of companies that didn’t quite match expectations.
While JPMorgan’s research is correct in that daily volatility has become sharper and more intense, others are equally making the observation that many more share prices could have been slaughtered under different circumstances, but they received rather mild responses instead.
Indeed, UBS is arguing average volatility this month is actually down in comparison with prior seasons, on its own data analysis.
In ultra-simplistic terms: investors knew uncertainty and unknowns would dominate this season, and they had already decided to adopt the glass half-full approach.
This observation is further underpinned by the fact that share prices for companies that do not provide guidance for the year ahead on average have risen by 2% post financial results release.
Note also: the ASX200 has, on balance, gradually crept up higher as the season progressed. Led by, as UBS likes to emphasise, stocks trading on high Price-Earnings (PE) multiples.
As at Monday, 24th August 2020, the FNArena Corporate Results Monitor contained 159 results of which, on our holistic assessment, 54 beat expectations (34%) and only 28 missed (17.6%).
Never in the history of the Corporate Results Monitor have we ever witnessed the Beat/Miss ratio this close to 2. The highest ratio recorded since 2013 was 1.5 for both August 2015 and February 2016.
I don’t think it’s unreasonable to expect the percentage of misses to increase over the remaining days.
Equally noteworthy, the numbers yet again look a lot less promising for the ASX50, with only nine beats out of 37 (24%) versus ten fails (27%).
Earnings forecasts are declining, as they do in just about every reporting season, but price targets are going up by more than 4%, which is high on historical precedents, but not unprecedented.
Upgrades and downgrades in broker ratings in response to financial results are to date perfectly balanced; 34 each.
High valuations, carried by the themes of “Quality” and “Growth”, as well as “covid-19 beneficiary”, have remained one of the stand-out features, yet again, this month.
Despite the gap between “winners” and “losers” at an all-time high pre-covid earlier in the year, market strategists at UBS observe that gap is simply refusing to narrow.
If anything, it just keeps getting wider as shares for the likes of Afterpay ((APT)), WiseTech Global ((WTC)), Netwealth ((NWL)), ARB Corp ((ARB)), etc continue to reach for higher prices, while investors have no appetite for the likes of Whitehaven Coal ((WHC)), Vicinity Centres ((VCX)), Unibail-Rodamco-Westfield ((URW)), and Orora ((ORA)).
An important observation in this regard is that analysts’ expectations for FY21 are for rather benign growth, in particular given the large decline experienced in FY20. Rising costs and the need for additional investments are only part of this story.
Strategists at Morgan Stanley summarised it as follows: the upgrade cycle for corporate Australia has yet again been delayed.
FY22 now marks the earliest return of growth for the majority of Australian companies. I think this virtually guarantees the extreme polarisation that has characterised the share market post 2013 is here to stay for longer.
The good news is that when FY22 does live up to current expectations, average EPS growth might jump by 16%, as per current forecasts at Morgan Stanley.
But there is a long way that yet needs to be traveled between now and then.
For what it’s worth: Morgan Stanley sees the share market as stretched in valuations given the absence of growth between now and FY22.
Only few companies have provided quantitative guidance, and most of such guidance has been negative a la AGL Energy ((AGL)), Origin Energy ((ORG)), Telstra ((TLS)), Challenger ((CGF)), and Seek ((SEK)).
Macquarie identified the few from the Top100 that have come out with concrete, positive guidance as: WiseTech Global, Goodman Group ((GMG)), Amcor ((AMC)), CSL ((CSL)) and Brambles ((BXB)).
That is by anyone’s account, not an extensive list.
Best results delivered so far, according to Maquarie, have come from Charter Hall ((CHC)), Nick Scali ((NCK)) and Baby Bunting ((BBN)), followed by JB Hi-Fi ((JBH)), Charter Hall Long WALE REIT ((CLW)) and Codan ((CDA)).
Worst results were the ones from Vicinity Centres, Santos ((STO)), Qantas ((QAN)), AGL Energy, Seek and GWA Group ((GWA)).
Themes that have emerged as clear winners (and losers) this reporting season, include:
-Covid-19 is good for housing with work-from-home putting pressure on offices;
-Car ownership is back in fashion too, with public transport on the receiving end;
-This pandemic has created booming conditions for parts of the retail sector;
-Mining and mining services remain robust, as long as there is no connection to coal
And then there was the matter of dividends…
On Macquarie’s numbers, nearly 60% of companies have reduced their dividend at least by -10%, while nearly 25% increased dividends by +10% or more.
The good news is nearly 70% of companies are still paying a dividend, with 23% reducing their dividend to zero for the half.
Real Estate delivered most of the dividend cuts, followed by Resources.
On my own observation, many of the laggards have stuck to the script that when all else fails to deliver, it’s best to at least provide shareholders a surprise through the dividend.
Witness, for example, even the board at South32 ((S32)) couldn’t help itself but pay out a symbolic US1c this half – better than nothing!
Within this context it is interesting to note that, on Citi’s observation, investors chose to reward banks that delivered better earnings results this month (including through trading updates) rather than an extra effort through paying a dividend.
In line with assessments elsewhere, banking analysts at Citi believe bank share prices look cheaply valued, but the key challenge is yet to come in Q4 when government stimulus is wound back, deferred loan periods have expired and unemployment is expected to peak in Australia.
Market strategists at Citi have identified three key dividend surprises this season: AMP ((AMP)), Newcrest Mining ((NCM)), and Woodside Petroleum ((WPL)) in that market forecasts for all three dividends have increased for both this year and next.
On current trends, market consensus is likely to settle around -22% in earnings per share (EPS) retreat for FY20, to be followed by circa 6% growth in FY21, which might then be followed by 13.4% growth in FY22.
Utilities, as a group, are not expected to join in the return of growth, while Technology, Healthcare, Insurance, Gaming and Staples are presenting themselves as key drivers for those growth projections for the years ahead.
Expectations for banks are unusually mixed. The sector is responsible for the largest downward corrections in dividend forecasts this season, followed by real estate, then other financials.
The largest upward revision in price target surely goes to online artwork market-place Redbubble with stockbroker Morgans lifting its target on Monday to $4.33 from 54c previously.
UBS has tipped NextDC ((NXT)) for a potential positive surprise on 27th August.
Early Signals From August 2020
At first glance, this year’s August reporting season is providing support to the strong share market recovery witnessed since April, decisively delivering more “beats” than “misses” in corporate results and with stockbroking analysts increasing their price targets on average by 4.79%.
As per always, broader context is necessary to put the first two weeks of August in a proper framework.
The most important factor to consider is that the FNArena Corporate Results Monitor as at the 17th August still only includes 55 ASX-listed companies with subsequent broker responses.
While the Monitor operates on a 24-hour delay, the time needed for analysts to respond and reassess, properly, 55 companies to date is well below prior reporting seasons this far into the month.
Hence, it’s dangerous to draw firm conclusions from such a small batch of reports, involving no more than 15 members of the ASX50 and 35 of the ASX200, but it cannot be denied early indications are relatively positive and investors are showing a willingness to look through short-term headwinds, as I anticipated.
We will all be a lot wiser by this time next week, but as early indications go this season is heading for:
-circa -20% fall in earnings per share
-circa -38% reduction in dividends, with payout ratios on the rise (again)
-mild growth forecasts for FY21 (meaning growth won’t return until FY22 for many)
-on balance, net increases to valuations & price targets
-roughly balanced moves between upgrades and downgrades in stockbroker recommendations
-ongoing uncertainty with most companies refraining from providing FY21 guidance
The biggest positive stand-out has come through numerous upside surprises for shareholder dividends, including from AGL Energy ((AGL)) whose dim outlook surprised many, but the AGL board decided the company shall payout 100% of profits over the next two years.
The AGL example serves as an early guide as to how Australian boards (still) feel compelled to use just about anything at their disposal in order to meet the income requirements from a large group of domestic shareholders.
Apart from AGL, more dividend surprises have come from AMP ((AMP)), Aurizon Holdings ((AZJ)), Evolution Mining ((EVN)), GPT Group ((GPT)), Newcrest Mining ((NCM)), and QBE Insurance ((QBE)) while CommBank’s ((CBA)) 98c H2 payout was more than many analysts had penciled in.
Of course, as the above summary indicates, many more companies will not be paying any dividends this year, or next year, but many others won’t be holding back, effectively creating yet another demarcation between “winners” and “losers”.
As many of the dividend payers are receiving support from government programs such as JobKeeper, a public discussion has broken out about the appropriateness of such payouts.
The irony from this reporting season, thus far, is that the miners are swimming in cash, and showing restraint in paying out dividends, also because costs are rising and more capex needs to be spent.
On FNArena’s early assessment, some 34.5% (19) of companies reporting has beaten market expectations while only 16.4% (9) delivered a “miss”.
If these numbers hold up until early September, then 2020 would easily become the best August reporting season in Australia since 2013, but, again, too early to make such projections.
What we can assess is that already a number of companies have crowned themselves to stand-out winners and losers for the season.
On the positive side, Goodman Group ((GMG)) yet again showcased to investors just how strong the shift to online spending has become.
It wasn’t that long ago Goodman Group shares offered no more than 3.5% prospective yield, which elicited quite the number of calls denominating the stock “grossly overvalued”, yet today the yield stretches no farther than 1.6%, signalling the stock has (more than) doubled in price since 2016.
And still growing strong, with analysts further lifting growth estimates, which elevates price targets further, allowing traders and investors to push up the share price higher without the risk of running out of oxygen.
Another positive stand-out is REA Group ((REA)) whose FY20 release yet again showcased the true value of operating the number one real estate portal in the property-mad country that is Australia.
As with Goodman Group, REA Group shares have continued to climb and remain close to an all-time record high. The key difference is that analysts’ price targets are all below the present share price.
Rio Tinto ((RIO)) too delivered a strong performance, overshadowed by the board restraining itself with the half-year dividend, while James Hardie ((JHX)) remains clearly on a roll, and coal-stricken Aurizon Holdings equally delivered on promises and potential.
Some results were strong, but the market had other ideas. Hence the likes of ResMed ((RMD)) and Breville Group ((BRG)) received capital punishment post market update.
Long-term oriented investors should keep in mind these companies still have a lot of potential growth ahead of them.
At the risk of stating the obvious, it has become evident already some retailers are enjoying boom-conditions because Australians, simply put, don’t know where to spend their money otherwise.
I’ll say it again: highly valued companies are no more likely to disappoint during reporting seasons than laggards and cheaply priced companies.
What you won’t easily find is a highly valued stock that rallies 10% or more upon the release of company financials.
As such, owners of shares in AMP ((AMP)), Treasury Wine Estates ((TWE)), Baby Bunting ((BBN)) and Navigator Global Investments ((NGI)) are feeling a lot happier today than those who own Goodman Group and REA Group.
But what about shareholders in AGL Energy? Challenger Financial ((CGF))? Or in Telstra ((TLS)) which, according to some analysts, seemed poised to drop the mantle of perennial disappointer this month, but it simply was not to be.
Telstra pretty much dropped yet another booby trap among investors, creating even more doubt about dividend sustainability and the way forward for Australia’s largest telco.
It wasn’t that long ago that I reminded investors that with so many unhappy customers, a conglomerate so much under pressure is highly unlikely to elevate itself to a position -ever- from where it can deliver long-lasting, sustainable benefits for loyal shareholders.
Post Telstra’s FY20 report, the share price is back hovering above the $3 mark, not far off from the March low, while analysts’ updated forecasts are implying lower dividends this year, and yet again in FY22.
Investors should also consider the annual receipts from the NBN will cease not long thereafter.
I am increasingly leaning towards the idea that Telstra is looking into creating value through cutting itself up in smaller pieces, which shall be spun-off in order to make the sum of the parts count for more than the conglomerate in its current form.
Job classifieds market operator Seek ((SEK)) too spooked investors with a much more fragile assessment of what the future might look like ex-China.
A special mentioning goes out to Hamish Douglass and the rest of the crew at Magellan Financial Group ((MFG)).
Not only are they one of few asset managers in Australia who operate on the right side of the market shift caused by low growth, low inflation, ageing demographics and super-charged technological disruption, like other iconic success stories elsewhere, Magellan has yet again proven a great company is not afraid to disrupt itself.
Instead of staring oneself blind on a high/low Price-Earnings (PE) ratio, or high/low implied dividend yield, many an investor would do their portfolio one massive favour by paying attention to the attributes that don’t show up in an Excel data overview, but which shall be the subject of academic dissertations for years to follow.
Investors should also note stocks like Goodman Group, REA Group, and ResMed are proudly owned by the FNArena/Vested Equities All-Weather Model Portfolio (see also further below).
Paying subscribers can check up on my research into All-Weather stocks via a dedicated section on the website (with fresh updates on Dividend Champions):
August 2020: Early Results
The local reporting season in Australia is slowly gathering pace. Let’s remind ourselves how important financial results are for market sentiment and thus for how share prices will be treated for the weeks and months ahead.
Often, how companies are being judged is through the lense of: beat or disappointment? Black or white. Superb or poor.
That judgment is made not on the 30% profit growth, or the decision to pay out a dividend, or the heavy losses incurred during lockdowns or bushfires, but on how the financials compare to what analysts had penciled in their modeling.
The ruling narrative is companies which disappoint might see their share price underperform for up to four months, while those who manage to surprise positively are most likely rewarded with longer-lasting outperformance.
That’s one side of the story.
The other side is that sustainable, structural growers can disappoint with their market update, and all of CSL ((CSL)), Cochlear ((COH)), REA Group ((REA)), TechnologyOne ((TNE)), and others have at varying times done exactly that, with direct consequences for the share price in the immediate aftermath.
But take a longer-term view, and what do we see? Every single one of those sell-offs today looks nothing but a temporary blip in an ongoing, long-term uptrend.
And that, I like to think, is the key message investors should keep in mind when volatility hits this reporting season.
The early stage of the August reporting season saw REA Group showing off its in-built resilience, while ResMed’s result was better-than-expected but downgraded as “low quality” with cautious guidance by management not received well by flighty traders.
Clearly, day-to-day operations for healthcare bellwethers CSL, Cochlear and ResMed have been impacted by the virus and forced lockdowns, but the real question investors should be asking is whether this means these companies are running out of puff and soon will find themselves having turned ex-growth.
You know my opinion on this. All three, as well as REA Group, remain firmly embedded in my selection of All-Weather Stocks on the ASX.
Admittedly, a continuing strengthening of the Aussie dollar, as predicted by some, will complicate the outlook for foreign earners in Australia, but when it comes to forecasting FX, most experts’ track record is not something to boast about.
Shorter term, market forecasts and expectations have seldom been as wide as for FY20, including for healthcare companies with most having withdrawn guidance, leaving analysts and investors to speculate what can and should be expected.
One positive stand-out to date is Ansell ((ANN)), not a typical healthcare stock, but Credit Suisse believes this is the early stage of a structural switch that will put the company’s growth outlook on much firmer footing.
The most talked about remains, of course, Australia’s number one biotech stock, CSL. It’ll be interesting to see how much guidance management is prepared to share regarding the outlook for plasma and other parts of the business in FY21, and beyond.
CSL is too complex for most investors during less complicated times. This time around it’s anyone’s guess what will become the focus post reporting on August 19.
Outside of the local healthcare sector, analysts are still busy assessing what might and can be revealed this month, but investors should appreciate uncertainty has seldom been at this year’s level.
For sectors including airports, airlines, accommodation, travel and leisure, and Australian banks, August comes too early; many questions will remain unanswered. Analysts anticipate companies might defer to the AGM season in November when attempting to predict what comes next.
Iron ore producers are generating lots of cash, but how cautious will company boards be when deciding how much to pay out in dividends to shareholders?
Sectors like oil and gas producers will have horror updates to make, including the scrapping of dividends and capex/expenses, while writing down the value of assets – but investors are very well aware of it all.
Meanwhile, portfolio rotation (or at least: attempts to it), currency movements and other macro factors will continue to impact on general sentiment and share prices.
August 2020: Nothing Like The Past
Corporate earnings have not been front of mind for share market investors over the year past.
Last year’s August reporting season marked the weakest performance for corporate Australia since the GFC, yet 5.5 months later the ASX200 surged to an all-time record high of 7162.50.
Meanwhile, in the background of it all, dividend payers in Australia, including the major banks, had already started to reduce nominal payouts.
Corporate reporting in February was fully overshadowed by the realisation that a global pandemic was spreading fast.
Since then we had global lockdowns, social distancing, an accelerated race for a vaccine, treatment or cure, recessions, central banks liquidity and credit support, government safety net programs, and regional virus drawbacks, but no profit warnings as company boards in Australia have been temporarily excused from the legal requirement to keep investors fully informed.
It is probably a fair assessment that August 2020 is taking place amidst the highest level of uncertainty for a very long time.
As to how exactly investors are going to respond to corporate profits and the lack thereof throughout the month ahead is anyone’s guess, especially with so many expert voices proclaiming equities are pricing in too much optimism.
The first eight corporate results during the final week of July don’t offer much in terms of blue print. Only one of those eight -Credit Corp ((CCP))- was able to issue earnings guidance for the year ahead.
None of the share prices put in a big rally post event, but several have seen profit-taking and weakness kicking in since, including Credit Corp.
Then again, Credit Corp’s in-line FY20 profit result was no less than -78% below prior guidance, which had been withdrawn in March.
Cimic Group ((CIM)) missed expectations, Emeco Holdings ((EHL)) reported in-line with just about everyone calling the stock undervalued and Rio Tinto ((RIO)) surprised on the upside in what could become the broad context for the commodities sector in general this month.
A cautious Rio Tinto board did not surprise with a bigger-than-expected dividend announcement.
Covid-19 has accelerated the adoption and acceptance of new technologies and trends, further widening the gap between winners and losers in the share market, so it probably shouldn’t surprise online retailer Temple & Webster’s ((TPW)) result was generally well-received.
Again, Temple & Webster shares have seen some profit-taking kicking in post event.
Three of the eight companies have indicated how important government support programs are to their operations and profitability. This too adds to the general uncertainty.
Investors will continue their focus on dividend reliability and sustainability, but in many cases they will have to make assessments in the absence of any concrete guidance from the companies themselves.
Realistically, how much can one expect from airports and airlines, for example, whose revenues have been decimated without any insights as to when their operations might “normalise”?
Numbers from the US too confirm more companies prefer not to issue guidance for the year ahead with only circa one-in-four confident enough to do so, and this includes negative adjustments.
I wouldn’t be drawing on too many references from the past this reporting season. It’s a whole new ball game this season, and macro matters remain plenty and all-important.
One of the key characteristics of 2020 is that the virus has disrupted the concept of what makes a “defensive” company or asset.
Even outside of banks, and operators of toll roads and airports, many financials and industrial companies are now offering reduced yields.
It’ll only further add to the determination of many an income-hungry investor.
Australian investors already had to adjust for the erosion of the age-old concept of blue chips in the share market. Now “defensive” no longer means what it used to be.
Which shoe will be dropping next? Safe as houses?
On most forecasts, dividend reductions this year might approach the carnage of the GFC, possibly worse. And August is not necessarily the end of this sorry narrative.
Analysts at Citi recently lined up forecasts for the top 50 dividend payers on the ASX. The small list of stocks that are expected to continue increasing dividend payments in the years ahead includes CSL ((CSL)), Unibail-Rodamco-Westfield ((URW)), Amcor ((AMC)), Coles ((COL)), APA Group ((APA)), Goodman Group ((GMG)), Aurizon Holdings ((AZJ)), ResMed ((RMD)), Medibank Private ((MPL)), Magellan Financial Group ((MFG)), Computershare ((CPU)), Evolution Mining ((EVN)) and Charter Hall ((CHC)).
Not all these stocks are trading on low enough multiples to guarantee a reasonable yield. UR-Westfield remains under threat of a capital raising as well as further write-downs of asset values.
Companies for whom a dividend reduction might just be a one-off include BHP Group ((BHP)), Wesfarmers ((WES)), AusNet Services ((AST)), Dexus Property Group ((DXS)), GPT Group ((GPT)), Janus Henderson ((JHG)), Sonic Healthcare ((SHL)), Mirvac Group ((MGR)), Lendlease ((LLC)), and Coca-Cola Amatil ((CCL)).
In what might well be regarded as very uncharacteristic for the decade’s best performing sector on the ASX, healthcare has traded in early safe haven outperformance for notable underperformance post late-March.
Behind this observation hides yet another widening gap, with the likes of ResMed, Sonic Healthcare, Ansell ((ANN)), and Fisher & Paykel Healthcare ((FPH)) surging to new all-time record highs, while CSL, Cochlear ((COH)) and Ramsay Health Care ((RHC)) have been left behind.
Recent analysis by JP Morgan revealed many institutional investors have been adding to their healthcare exposure in June, no doubt encouraged by the relative de-rating for the laggards in the sector.
JP Morgan strategists reported they are equally inclined to follow suit as the outlook for risk assets favours a more defensive portfolio stance.
Data suggest the largest fund inflows went into ResMed and Ramsay Health Care shares in June.
JP Morgan reports funds managers’ skew towards healthcare stocks has reached the highest positive level in the history of its survey.
Equally noteworthy is that more and more institutional portfolios have been adding banks to their top ten positions, while reducing exposure to “Materials” (essentially miners and energy producers).
To read more about the raging debate about what to expect from CSL this month:
You wouldn’t pick it from the outside, but Australian telcos could potentially turn into one of few stand-out performers this August reporting season.
Analysts at Goldman Sachs point out all major telcos have reiterated guidance for FY20, and thus investor focus will zoom in on what each company is willing to share about the outlook for FY21.
Goldman Sachs thinks every telco under coverage will provide guidance, which will be unique this season, albeit with the added understanding that some companies might prefer to issue a rather broad range.
Irrespective, if Goldman Sachs’ assessment is correct, telecommunication might be vying for top sector spot in terms of reliability and accountability this month.
The broker’s top three favourites ahead of the season are (in order of preference) Telstra ((TLS)), NextDC ((NXT)), and Vocus Group ((VOC)).
Telstra is expected to attract additional interest on confirmation of dividend sustainability.
Sector analysts at Morgan Stanley agree with the general sentiment, but they also see potential friction for the industry because the combined TPG/Vodafone ((TPG)) is ambitious enough to disturb the relative peace from the past twelve months.
In contrast with the above, analysts at Credit Suisse suspect diversified financials might be one of the disappointment hot spots this month.
All of Challenger ((CGF)), Computershare, ASX ((ASX)) and Hub24 ((HUB)) have received one big question mark to their name and Credit Suisse sees risks as firmly to the downside.
Only one sector constituent continues to offer scope for upside surprise, Credit Suisse believes, and that one stand-out name is, of course, Magellan Financial Group ((MFG)).
The analysts are anticipating positive commentary on new product launches, as well as regarding the fresh investment banking startup, Blackwattle.
All other non-bank financials ex-insurers are trading amidst neutral to mixed operational conditions, and Credit Suisse cannot muster the slightest hint of excitement.
Plenty of analysts elsewhere who’d find Credit Suisse’s neutral view on the likes of Platinum Asset Management ((PTM)), IOOF Holdings ((IFL)) and Link Administration ((LNK)) potentially too rosy.
Another sector under immense pressure is media, in particular those business models depending on revenues from advertising, which also includes outdoor advertising facilitators.
Cyclical earnings risk galore is probably the appropriate label to use here. Morgan Stanley sees only one winner (or should that be: survivor?) among traditional media players, and that’s Nine Entertainment ((NEC)).
While valuations for online media and modern-day tech companies are back near all-time highs, the debates amongst analysts and investors continues to rage, and to divide, whether current multiples are outrageous or fully justified.
Aristocrat Leisure ((ALL)) remains Morgan Stanley’s gaming & casino sector favourite and that’s partially because of the growth potential from online gaming.
August 2020 will mark a sharp divide for the mining sector, explain commodity analysts at Credit Suisse.
In particular coal producers are struggling with a persistently tough environment. The analysts have removed all estimates for any form of dividend payments to shareholders.
For others, including Alumina Ltd ((AWC)) and Iluka Resources ((ILU)) Credit Suisse has adopted cautious forecasts of US2c and AU4c respectively while BHP Group ((BHP)), irrespective of no positive surprise from Rio Tinto’s ((RIO)) interim result, has the capacity to do better than cautious market expectations.
It’s all about the price of iron ore remaining above US$100/tonne, and this is the reason why Fortescue Metals ((FMG)) could pay out more than expected as well.
For now, the analysts have penciled in AU77c for Fortescue Metals shareholders and US43c for BHP shareholders, but both estimates could be proven conservative.
Capital management will be greatly welcomed amidst extreme uncertainty, and one of the companies often mentioned in this regard is Aurizon Holdings ((AZJ)).
The company bought back $400m worth of its own shares in FY20. More is expected in the year ahead.
In contrast, Brambles ((BXB)) has only bought circa 25% of its announced $240m on market share buyback.
Analysts are worrying the new dividend policy might result in a disappointing outcome for shareholders.
All of the above, and much more, shall be dismissed or confirmed over the weeks ahead.
Coming Soon: The August Reporting Season
On many accounts, the August reporting season about to be unleashed upon investors in Australia will mark a new low post-GFC, which ended 11 years ago.
This does not by default imply the Australian share market is ready for a big sell-off in the weeks to come.
Investors are being reminded markets do not compare in absolute numbers or values. It’s all about matching what is forecast, what is priced in and what can ultimately be achieved.
Reporting seasons are mostly about changes to forecasts (and perceptions) rather than what companies have achieved.
Within this framework it remains an open question as to what conclusions exactly can be drawn from company financials and updates when macro developments remain all-important, and unpredictability of events and outcomes high.
We are less than 3.5 months away from the US presidential election, to name but one of the obvious obstacles to make far reaching predictions with any sense of conviction.
Companies will be reluctant to provide concrete guidance, but those who can/do will be rewarded for it.
Analysis of the five months since the pandemic spread teaches us that concrete guidance will be rewarded with share price outperformance.
Makes a lot of sense, if you think about it, as long as that guidance doesn’t need to be withdrawn later.
Bad news is not necessarily the equivalent of a fatal blow, as also shown by energy producers and shopping mall owners pre-season. Large write-downs of assets had investors merely shrugging their shoulders: tell us something new!
We saw those write-downs coming from many miles away.
Investors are definitely looking forward, in many cases to FY22 which is not one but two years away, which means high tolerance for bad news in the short term, as long as it doesn’t impact on FY22 estimates and derived valuations.
(This also shows, once again, why the macro picture remains the all-important denominator).
There is some anticipation that boards and management teams will grab the opportunity to clean balance sheets and get rid of a lot more baggage than otherwise would have been the case.
Again, this means: even more bad news will be thrown into the open.
Earnings estimates, on average, have been reduced by -15% and dividend cuts will be larger still, double the cuts in profits on some forecasts, which will make 2020 the worst year for income seekers in a long while.
Equally noteworthy: most forecasts assume no growth, on average, in FY21. A lot of weight is thus placed on recovery prospects by FY22.
Wat sets this year apart from past references is that the global pandemic created beneficiaries in the form of medical tests, ventilators, sanitisers, home entertainment and online shopping.
There were no obvious beneficiaries around when the Nasdaq bubble burst or when Lehman Bros went bankrupt.
Hence, more so than ever, this year’s August reporting season comes at a time of extreme share market divergence – winners versus losers.
Whereas the losers might be enticed to spill the beans, throw out the kitchen sink, clean all the cupboards and create a springboard for future recovery and growth, no such leniency will be granted to companies whose share prices are trading near the all-time high.
Assessments will be made on a case-by-case basis.
None of this means losers won’t be punished or winners cannot positively surprise. If past reporting seasons can be our guide, day-to-day volatility might spike a few extra notches.
There is always room for disappointment and surprise.
Potential strong performances will be delivered by producers of iron ore and retailers enjoying the spoils from government stimulus programs JobKeeper and JobSeeker. In both cases investors will be wondering: how sustainable is this?
Dividends from mining companies are expected to make up one third of total payouts, also because banks probably won’t be paying anything.
Some analysts are forecasting a big revival for banking profits in 2021. Some are forecasting a large fall in profits for mining companies next year.
These questions will not be resolved in August.
Sectors that on current forecasts are looking towards two subsequent years of pain are transport, insurance, diversified financials, and infrastructure.
Cash flows and balance sheets will be in constant focus, as will be “dividend certainty”.
More write-downs and revaluations are expected, as well as additional capital raisings.
Meanwhile, it’s probably still OK to talk about consensus forecasts and average reductions, but underneath the bonnet the divergences are as wide as during the GFC – expect large resets either way.
Some analysts are grabbing the opportunity and reiterating their conviction in forecasts that are well out of synch with consensus.
Wilsons, on Tuesday, nominated ARB Corp ((ARB)), a2 Milk ((A2M)), Nick Scali ((NCK)), SomnoMed ((SOM)), Bravura Solutions ((BVS)), NRW Holdings ((NWH)), and Perenti Global ((PRN)).
Other companies for which simply achieving guidance would imply a significant upward adjustment for market consensus include AMA Group ((AMA)), AP Eagers ((APE)), Costa Group ((CGC)), Whitehaven Coal ((WHC)), New Hope Corp ((NHC)) and Monadelphous ((MND)).
Wilsons sees downside risk for GUD Holdings ((GUD)), Ramsay Health Care ((RHC)) and Nanosonics ((NAN)).
Goldman Sachs likes QBE Insurance ((QBE)), Suncorp ((SUN)), Computershare ((CPU)), Pendal Group ((PDL)) among non-bank financials, while investors are advised to sell ASX ((ASX)), Platinum Asset Management ((PTM)) and Medibank Private ((MPL)).
Stockbroker Morgans believes domestic cyclicals need to deliver better-than-expected results plus confirmation of an improving outlook for the ASX200 to be able to break out of its current narrow range.
Tech stocks may find beating forecasts is difficult given high expectations, but resources companies, in particular those exposed to iron ore and copper, might be able to surprise both on profits and dividends.
Candidates for a potential positive surprise include a2 Milk, AP Eagers, AGL Energy ((AGL)), Superloop ((SLC)), Afterpay, Amcor ((AMC)), and Domino’s Pizza ((DMP)).
Morgans sees Telstra ((TLS)) potentially surprising through capital management.
Nominated for possible disappointment are Ramsay Health Care ((RHC)), Link Administration ((LNK)), Orora ((ORA)), Qube Holdings ((QUB)), Coca-Cola Amatil ((CCL)), and Woodside Petroleum ((WPL)).
Morgans also suggests both CSL ((CSL)) and Cochlear ((COH)) look vulnerable for a valuation de-rating.
Finally, while expectations are low -admittedly for good reason- average valuations look sky-high, which usually provides the ideal scenario for lots of volatility to kick in.
I wrote a story earlier in the month why valuations are probably not as much out of order as many are arguing, see further below.
I leave the closing statement to Morgan Stanley:
“Despite investor feedback that earnings 'don’t matter' amid the Covid-19 crisis, we think FY20 earnings are important. In a world where guidance has been withdrawn, earnings estimates are stale and earnings dispersion is very wide, the looming refresh will provide much-needed context and depth to what have typically been updates that have been narrow in focus and scant on detail. Cash flows, margins, capex and balance sheets can now come back to base.”
ON THE FEBRUARY REPORTING SEASON:
February Reports: The Green Divide Is Real
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.
Bell Potter's three sector favourites are Monadelphous ((MND)), Lycopodium ((LYL)), and Service Stream ((SSM)). The latter has already reported, and avoided both disappointment and project mishaps.
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:
February Reports: Equity Favourites And Warnings
Paying attention to stockbroking analysts announcing their Conviction Buys and Sells can be highly beneficial to one's investment portfolio, as no doubt experienced by many an FNArena subscriber.
Over the past two years in particular, I have methodically kept track of Conviction Calls in the market, and those have included ResMed, Magellan Financial Group, IDP Education, Cochlear, Goodman Group, Appen, EML Payments and various other high flyers.
Every now and then these Conviction Calls generate an absolute blooper; the stinker that leaves a bad taste that simply won't go away. Boral and Challenger Financial come to mind, as well as EclipX Group and G8 Education.
In January we had the profit warning from Treasury Wine Estates ((TWE)) which, on one hand, vindicated the persistent Sell rating maintained by analysts at Citi, irrespective of their peers releasing more bullish assessments.
On the other hand, the Buy ratings that stood out prominently in December and early January subsequently led to four downgrades to Neutral while for Citi it was time to upgrade to Neutral, as the share price tanked.
One team of analysts that hasn't budget post profit warning and quite the significant de-rating for the stock is the team at CLSA.
The analysts were left licking their wounds, but subsequently stated they had been negative on the US market anyway. It's the company's growth prospect in China that keeps optimism alive, and CLSA's rating on Buy.
Analysts Richard Barwick and Deija Li cannot believe how "cheap" the share price looks today (it has been falling on most days since the day of warning).
But even they have to acknowledge, Treasury Wine has now de facto become a long-term story. Short term, there are a number of investors out there who lost a lot of money, and they'd be vying for blood & revenge. Don't be surprised if Treasury Wine remains in the naughty corner for quite a while.
In the meantime, there are no guarantees the bad news flow won't continue for longer.
On my own observations, and I have some incomplete data to support this statement, most declared Conviction Calls perform better than the market average, which is why I thought it apposite to share the various favourites and Hot Stocks that have been picked ahead of the February reporting season.
The obvious comment to make is that sudden warnings, like the one issued by Treasury Wine, if such event were to occur, can change a stock's trajectory dramatically. The same goes for share price movement and the profit report release itself this month.
Diversified financials are expected to release weak results this month, potentially with the exception of Magellan Financial. Analysts at Credit Suisse see potential for negative surprises and have lined up Challenger Financial ((CGF)), Netwealth ((NWL)), Perpetual ((PPT)), Hub24 ((HUB)), and Link Administration ((LNK)) as stocks carrying additional negative potential.
Noteworthy: outside of Magellan, no other stock in this sector is seen as a potential upside surprise.
Credit Suisse finds more hope could be emerging from the insurance sector where even AMP ((AMP)) is seen as a stock that might have upside on a not-as-bad-as-feared results release, accompanied by some clarification from management around customer remediation.
QBE Insurance ((QBE)), AUB Group ((AUB)) and Steadfast Group ((SDF)) are equally believed to carry upside surprise potential. The odds seem less favourable for the likes of Suncorp ((SUN)), Insurance Australia Group ((IAG)), Medibank Private ((MPL)) and nib Holdings ((NHF)), at least if Credit Suisse's pre-release assessments prove accurate.
Stockbroker Morgans is concerned elevated share prices might not necessarily be followed up with robust looking earnings results this month.
On its assessment, the best looking tactical buys this season -stocks whose share price looks poised to react positively to the release of results- include BHP Group ((BHP)), Rio Tinto ((RIO)), Telstra ((TLS)), Aurizon Holdings ((AZJ)), and Baby Bunting ((BBN)).
Stocks that are expensively priced and probably due for disappointment, according to Morgans, include Wesfarmers ((WES)), AGL Energy ((AGL)) and Qube Holdings ((QUB)).
Morgans has also pinpointed some potential recovery stories through Ansell ((ANN)), Amcor ((AMC)), Santos ((STO)), and Woodside Petroleum ((WPL)).
Other candidates for earnings upside risk are Australian Finance Group ((AFG)), Infigen Energy ((IFN)), and Adairs ((ADH)) while yet others seem poised for a better-than-priced-in outlook guidance, including Afterpay ((APT)), Generation Development ((GDG)), IDP Education ((IEL)), Mainstream Group ((MAI)), Pro Medicus ((PME)), and Megaport ((MP1)).
JPMorgan's key picks among small industrials are cloud services provider Rhipe ((RHP)) for positive news (Top Pick) and debt collector Collection House ((CLH)) with a negative outlook (Bottom Pick).
Analysts at Wilsons updated their Conviction Insights, revealing two new additions and two removals. Nuchev ((NUC)) and Telix Pharmaceuticals ((TLX)) are now in, while National Veterinary Care ((NVL)) and Ridley Corp ((RIC)) are out.
Other stocks on the list are Bravura Solutions ((BVS)), EML Payments ((EML)), ReadyTech ((RDY)), Whispir ((WSP)), ARB Corp ((ARB)), ImpediMed ((IPD)), Countplus ((CUP)), EQT Holdings ((EQT)), Pinnacle Investment ((PNI)), Mosaic Brands ((MOZ)), Mastermyne ((MYE)), Perenti Global ((PRN)), and Whitehaven Coal ((WHC)).
Market strategists at Morgan Stanley are equally worried about the ever-widening gap between share price valuations and reported earnings in Australia.
It is their view that overall conditions for corporate Australia are not that flash, highlighting the need for more broader stimulus. But will the RBA and the Australian government hear the message?
Changes made to Morgan Stanley's Model Portfolio include removing Insurance Australia Group ((IAG)), Coles Group ((COL)), South32 ((S32)), Viva Energy Group ((VEA)), and Charter Hall ((CHC)) while instead buying shares in Janus Henderson ((JHG)), Sandfire Resources ((SFR)), Karoon Energy ((KAR)), and Wesfarmers.
Also, the Model Portfolio has again moved underweight the banks, while opting for more concentrated sector allocations, to reduce overall risk.
Strategists at Macquarie suggest investors should not be deterred from growth-leveraged companies with the coronavirus temporarily putting a dent into the global recovery story, but it's only a delay, in their view. The Chinese economy will be supported by further stimulus, while the US economy is anticipated to continue its recovery.
Post coronavirus, Macquarie sees bond yields ticking higher, which will reduce the attractiveness of defensives and yield proxies in the share market.
To gain from the immediate coronavirus impact, Macquarie suggests investors should buy into falling share prices of a2 Milk ((A2M)), BHP Group, and Fortescue Metals ((FMG)). All three are rated Outperform and included in the broker's Model Portfolio.
Other companies facing headwinds from the coronavirus, and likely candidates to bounce back later in the year, include Star Entertainment ((SGR)) and Flight Centre ((FLT)).
Macquarie's view is certainly not widely dismissed elsewhere, but investors might also pay attention to the latest research effort put in by analysts at Citi. On their account, short-term headwinds are building in China, and they have not as yet been priced into global commodity markets.
Citi sees iron trade trading down to US$70/tonne, copper to US$5300/tonne, palladium to US$2100/oz and Brent crude oil to US$47/bbl in the near term.
Citi's analysis has revealed the seven worst impacted provinces from the coronavirus in China account for 35%-40% of Chinese GDP, automotive output, property new starts, and in excess of 70% of air conditioner output.
The same regions only contribute 7%-26% of Chinese metals production, with exceptions of copper smelting at 45% and lead at 70%.
The Large Cap Portfolio at Shaw and Partners managed to keep pace with the fast running Australian share market in 2019, but since the coronavirus caught the world's attention, the headwinds have been quite tangible.
In response, the portfolio has moved Overweight local banks while abandoning REITs that are not covered by analysts in-house.
Shaw and Partners too believes any impact from the virus will prove temporary.
The portfolio has doubled down on Flight Centre, while increasing exposure to Macquarie Group ((MQG)), South32, and Goodman Group ((GMG)).
Potentially the most cautious ahead of the bulk of corporate results is Baillieu chief investment officer Malcolm Wood, who clearly believes the RBA et al are way too optimistic and the situation on the ground for the bulk of Australian companies looks a lot less promising.
The Baillieu strategist thinks market consensus is too optimistic. Top line growth will remain sluggish this season, Wood predicts, with companies about to reveal a lack of pricing power. Most companies have been enjoying some easing of raw material cost pressures, but forward guidances are likely to remain cautious, on his assessment.
What this translates to is an over-priced share market that thus becomes extremely vulnerable to any piece of negative news. Contrary to general optimism elsewhere, Wood sees earnings estimates trending lower throughout February, with companies in particular in consumer, financial, utilities and domestic facing industrials and healthcare sectors believed to be vulnerable.
To support his scepticism, Wood has kept track of local profit warnings since October last year. His line up contains 65 "significant profit warnings" offset by 16 upgrades. While the profit warnings have been broad based, positive warnings have come from global leaders and high-growth emerging companies.
In what may surprise investors, the Materials sector has issued most of the negative warnings with Incitec Pivot, Syrah Resources, Nufarm, Boral, Perenti Global and peers pulling back market expectations on the back of disappointing operational performances.
Industrials, Consumer Discretionary and Financials are the next three market segments co-responsible for the bulk of negative warnings, led by the likes of Cleanaway Waste Management, MaxiTrans and Prospa Group, Jumbo Interactive, G8 Education and Kogan, and FlexiGroup, IOOF Holdings and Medibank Private.
Even the healthcare sector delivered its fair share. Outside the international market leaders (of course), but through Monash IVF, Mayne Pharma, Estia Health, Healius, Regis Healthcare, and Australian Pharmaceutical.
The sixteen companies having issued "significant upgrades" over the period are Bapcor ((BAP)), oOh!media ((OML)), a2 Milk, ResMed ((RMD)), Sigma Healthcare ((SIG)), James Hardie ((JHX)), Amcor, Genworth Mortgage Insurance Australia ((GMA)), Macquarie Group, Emeco Holdings ((EHL)), John Lyng Group ((JLG)), Afterpay, Bingo Industries ((BIN)), Appen ((APX)), Fortescue Metals, and Charter Hall.
FNArena monitors corporate results the whole year around. Currently we are keeping track of February results releases. Paying subscribers to the service also have access to detailed reports for past seasons going back to August 2013. Make sure you check it out regularly:
Four Tips For Reporting Season
Continuing from our reporting season cooperation in recent years, FNArena is sharing insights from this year's February with readers and subscribers at Livewire Markets.
This year the cooperation includes an interview with yours truly, having been titled "Rudi's four tips for reporting season success".
A written summary of the interview can be accessed here, alongside the video:
The video is also accessible via YouTube:
February Reports: Optimism Is Back
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.
February Reports: Global Uncertainties, Profit Warnings, And..?
Last year, the two major corporate reporting seasons attracted larger than usual numbers of profit warnings in the weeks leading up to February and August. January this year has not generated similarly large numbers, but profit warnings are coming through nevertheless.
With share market indices near an all-time high, the response from nervy investors can be quite unsettling for shareholders owning the shares of companies issuing a warning.
One would have thought with bushfires raging through towns and villages in NSW and Victoria, and with anecdotal evidence signaling consumers stopped spending post Boxing Day, while the Aussie dollar tried to rally above US70c in the meantime, investors would be a little cautious ahead of the upcoming February reporting season, but the start of the new calendar year showed no such restraint.
We can all but wonder where the share market would be without the coronavirus, but the observation remains that profit warnings remain part and parcel of corporate profit seasons in Australia.
Market strategists at JPMorgan have kept track of the numbers, and shared some of their observations. Since mid-December, 17 companies included in the ASX300 have "confessed" their operations are not running in line with market expectations. Of these "profit warnings", discretionary retailers and industrials are responsible for the lion share, with the former sector alone accounting for one-third of all warnings thus far.
In response, one-day share price punishments have been quite severe with the average share price fall -16.5%. JP Morgan strategists observe the average downgrade to forecast earnings has been -15.5%, which is not dissimilar.
It is important to note JP Morgan's research does not include all profit warnings issued, which can be partially explained by a certain discretion about when negative news is a profit warning. I note, for example, insurers Suncorp and QBE Insurance are missing from the report, but Insurance Australia Group ((IAG)) is included. Equally, there is no mentioning of Gentrack Group ((GTN)) or Beacon Lighting ((BLX)).
Equally important, the strategists point out despite these warnings, the broader earnings trend for Australian companies remains positive leading into the February season.
Again, this remains subject to interpretation. On FNArena's observation, earnings estimates are definitely falling, an observation backed by analysts at Macquarie, though we agree with JP Morgan it appears small cap companies are faring worse than large caps.
At least thus far.
What cannot be denied is that multiple companies are enjoying upgrades in earnings forecasts and among those are companies that recently updated on financial performances, including Credit Corp ((CCP)), Afterpay ((APT)), GUD Holdings ((GUD)), ResMed ((RMD)), and Virgin Money UK ((VUK)).
Under "normal" circumstances, one might expect rising earnings forecasts translate into a rising share price, but with coronavirus and other macro-factors hitting investor sentiment, this has now become less of a certainty. Investors should note: this means there will be opportunities with less risk when companies perform well operationally but their share prices are being held back by macro-angst.
My own suggestion would therefore be to look for excellence in performance potentially followed by share price weakness because of macro concerns and herd behaviour. ResMed once again seems to fit the profile.
Looking For Beaten Down Bargains
Investors being investors, and above all: human, the animal instinct will direct many eyes towards the beaten down share prices of companies that disappoint this month. After all, everything has a price, n'est-ce pas?
It depends on one's strategy and horizon. Analysis and observations from past reporting seasons teaches us that shares in companies that surprise to the upside are most likely to outperform, at times up until three months and longer after the event, while share prices in companies that disappoint can continue to oscillate around bargain-basement price level, until the next catalyst arrives, which potentially could be the August reporting season in six months' time.
My personal insight is to watch what happens to analyst forecasts and valuations post reporting. If forecasts rise and valuations are pushed higher, and the share price isn't already trading well above revised valuations and price targets, you have most likely discovered an outperformer who might continue to outperform for longer.
Exactly the same formula works the other way around, unless an extremely cheap valuation triggers take-over speculation, or something similar. Investing in the share market is often said to be all about cashflows and profits, but when it comes to drawing lessons from corporate profit reports investors tend to be best off when they correctly assess the trend in profits and in profit forecasts.
Which is why jumping on cheap-looking stocks post unexpected profit warning is a strategy beset with elevated risk. I suggest, for investors with a longer-term horizon it is imperative to assess whether a profit warning has changed the growth outlook for the company beyond the short term.
In many cases it will do exactly that. This means investors need to re-assess what the outlook for this company looks like in the new context. This is not easy, given we are all influenced by the past, not in the least where share prices and valuations have been pre-profit warning.
From a personal perspective, I don't like companies that issue profit warnings. I can understand management teams cannot anticipate everything, and there is always room for an Act of God or an unpredictable setback, but in most cases profit warnings should have alarm bells ringing, and ringing loudly.
Most likely, they reveal not everything is running smoothly inside the organisation. Or management does not have a firm grip on the business, or doesn't understand the risks well, or is too optimistic in its messaging. It is also possible that sector dynamics are very fluid. Or that competition is getting a lot tougher. Or current management is simply not up to the challenge.
None of these reasons make for an attractive longer term investment, irrespective of how deeply a share price falls.
For investors who happen to own shares in companies that heavily disappoint, and that don't look like a great investment anymore within the revised context, I have but one key message: it is never too late to sell. It only takes one look at the share price graph of, say, Slater & Gordon ((SGH)) shares to underpin that statement.
This year's January confession season has impacted on my stable of preferred exposures in the local share market, with Treasury Wine Estates ((TWE)) and Nearmap ((NEA)) both issuing profit warnings. In both cases the share market reaction has been nothing short of savage.
Within my framework of finding All-Weather Performers, and combining my short-list of high quality performers with companies that have longer dated growth trajectories, I had included Treasury Wine under "Prime Growth Stories' and Nearmap under "Emerging New Business Models".
In both cases, the inclusions proved quite prescient for a while as share prices climbed to ever higher levels, but that was then. Now we know that, in Treasury Wine's case, the strategy to develop a new distribution model in North America is in tatters, and new management is looking for answers via an in-depth review.
Meanwhile, the odds seem very much in favour this company might be hit with more negative developments. Not in the least because Chinese cafes and restaurants are operating under the cloud of the spreading coronavirus. In Australia, grapes have been impacted by bushfires and the smoke these fires spread around.
For good measure: coronavirus-related impacts might prove temporary only and a shortage in high quality grapes locally might not have a large impact on the company's production of premium wines short-term, but these are tangible risks that won't go away simply because the share price has tanked.
Last year the Treasury Wine share price had weakened on speculation of hidden inventory build-up among distributors in China. It was a narrative spread around by hedge funds that had gone short the stock. As time went by, it seemed this malicious narrative didn't seem to stack up, and thus the FNArena-Vested Equities All-Weather Model Portfolio added some Treasury Wine shares.
By December, however, upon reading about problems inside the US division, it was decided to offload all those shares and reduce the portfolio's exposure to zero. In hindsight, this proved prescient. Or to use another term: lucky. We had no idea a profit warning was forthcoming only weeks later before the February half-yearly update.
Treasury Wine had been an outstanding performer from mid-2015 as the former division of Foster's finally got rid of its mediocre management-legacy and successfully executed on a strategy of "premiumisation" and increasing market share in China.
Taking a step back from all the positives that have occurred in the years past, of which some will continue in the years ahead, we have to conclude there is now potential for a lot of negative news flow, while risks remain elevated.
If the Model Portfolio hadn't sold all its shares in December, we would have sold post profit warning. Treasury Wine is hereby removed from the selection of Prime Growth Stories on the website. This doesn't mean all hope should be abandoned and this company can never again recover from the damage done.
What this does mean is that the company's overall risk profile doesn't suit the cautious, lower risk approach we prefer for the Portfolio. For similar reasons, we decided to sell the portfolio's remaining small exposure to WiseTech Global ((WTC)) in December. Too many unresolved question marks about the accounting in between subsidiaries and the mother ship need to be addressed with more transparency by the company.
Another grave disappointment was delivered by Nearmap, a company that arguably has everything at its disposal to become an international success story.
On Monday, Citi analysts explained why they remain optimistic longer-term post the January disappointment: Nearmap has a scalable business model, the current market share in North America, which is a large addressable market, remains tiny and there remains plenty of potential to move into additional geographies.
On the flipside, things clearly have not been running smoothly internally, an admission that was explicitly included in the written statement to the ASX. While management is likely to reduce the cash burn, the company is still not profitable and if more bad news were to follow, investors might start speculating about the need for extra capital.
This is probably partially why the share price is where it is today, which is well below targets set forth by stockbroking analysts (even post profit warning). I think the market is now anticipating a slower pace of growth for Nearmap in the years ahead. This might not be bad news in se, as it also reduces the potential for management to stretch itself and the company's resources too far.
But slower growth is slower growth, and if it turns out too slow this in itself can potentially result in more bad news through the share market allocating a lower valuation and, not to be completely dismissed, the company running out of cash before reaching break-even.
One observation that is firmly on my radar is the fact that management at Nearmap has now delivered three disappointments to the market in less than twelve months. This can be a sign of more negative news flow to come. Some of the corporate disaster stories from years gone by, including Slater & Gordon, iSentia ((ISD)) and Eclipx Group ((ECX)), started off with exactly the same pattern of successive disappointments.
Which is why Nearmap now sits in the naughty corner. One more negative piece of news, and we'll probably sell without thinking twice about it. In the meantime, we continue to re-assess, including asking ourselves questions about where to allocate the funds in the portfolio in the best possible manner.
Heavy turnover volumes in Nearmap shares post profit warning is likely an indication some institutional shareholders have now abandoned the register, while others have been waiting for the opportunity to get on board at a heavily discounted price, judging by the rally in the share price on Monday, when broad selling is dominating most ASX-listed entities.
As per always, this is what makes a market. Though not everybody is in it for the longer haul. Always good to keep this in mind.
Investors should know their own risk profile, level of experience, strategy and objectives, and act accordingly.
All-Weather Model Portfolio
Apart from the few minor adjustments in December as explained earlier, no changes were made to the FNArena-Vested Equities Model Portfolio thus far in 2020. Direct impact from slowing growth or the coronavirus on the portfolio should be rather benign, on our assessment, and we already shifted into a more cautionary composition in August last year, as explained at that time.
In January, the Portfolio's performance kept track with the broad share market. For the financial year to date (from July 1st onwards) the performance remains in excess of 4% above the ASX200 Accumulation Index, taking total return ex-costs to near 12.50%.
On our observation, expectations for a general revival of laggards/value stocks in Australia continue to be hampered by obstacles on the ground, while high quality performers continue doing what they do naturally and best.
I intend to conduct a general update on my stock selections post this reporting season in March.
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