Rudi’s View: August Bonanza, But What’s Next?

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

Rudi's View | Aug 05 2021

In this week's Weekly Insights:

-August Bonanza, But What's Next?
-Conviction Calls
-Research To Download

By Rudi Filapek-Vandyck, Editor FNArena

August Bonanza, But What's Next?

The upcoming August corporate reporting season should offer plenty of positives for Australian shareholders.

With both banks and large cap mining companies swimming in cash, there should be plenty of additional rewards on top of a strong recovery in post-2020 dividends. Both ANZ Bank and National Australia Bank have already indicated as much and Rio Tinto's larger-than-usual payout, including a bonus dividend, is equally but the first sign of what is likely to follow over the coming four weeks.

But the benefits that await from August stretch much wider; the quicker than anticipated economic recovery has fueled a much quicker than forecast recovery in corporate profits and balance sheets, and thus Australia awaits an even greater recovery in dividends across the board.

But wait, there is more, a lot more. Asset sales are providing the proverbial cherry on the cake with REITs and companies including Waypoint REIT, Telstra and Insurance Australia Group selling off parts of the business with the intention of (at least partially) passing on the proceeds to shareholders.

And, would you believe it, there is more, still. Increased confidence in that the world will overcome the challenges provided by covid, has interest in pursuing mergers & acquisitions spiking noticeably on the ASX. The latest such announcement came from Afterpay on Monday morning, informing investors its board had agreed to a full take-over by US-listed Square.

We already knew about suitors for Sydney Airport, Oil Search, Japara Healthcare, Spark Infrastructure, iCar Asia, and Iress among mid and larger cap names, but chances for the next suitor to announce itself for an ASX-listed target are improving by the day, or so it seems.

Can Treasury Wine Estates be next? Or Challenger or Praemium, maybe? How about Aerometrex, Bapcor or NextDC? Is Altium now fully off the hook? (See also last week's Weekly Insights for a list of potential targets).

Corporate Profits

In terms of corporate profits, the general expectation is that profits in aggregate are back to where they were pre-pandemic, though this won't be the case for every company individually, of course. Strong underlying support is provided by continuous upgrades to market forecasts which have now been rising for eleven months uninterrupted.

On average, earnings per share for the financial year that ended on June 30 are expected to have risen by circa 26%; this percentage is projected to rise to 45% for the year to December 31st, but for FY22 ending in June next year projected growth sits around 10% and by December 2022 it is close to zero.

One year ago, the average EPS in Australia fell by -19.3%. At the start of 2021, the forecast was for 8% EPS growth in FY21 (showing just how strong those upgrades have been since, carried by resources and financials).

What Comes Next?

The numbers above show the challenge for the Australian share market beyond August: how much growth is left beyond the initial V-shaped recovery?

The answer to that question might prove all-important because share markets are not cheaply priced. The local market's average Price Earnings (PE) ratio is still around 20x if current forecasts for the year to June 30 prove correct. But share markets are forward looking and that PE ratio falls to 17x-something by year-end and will shrink further by June next year if/when current growth forecasts improve further.

But can they?

The question will remain on investors' mind as countries struggle to vaccine populations and contain the virus, central bankers are looking for signs to start reducing liquidity and monetary stimulus, and bond yields might not stay at current depressed levels forever and always.

It would be a big ask for domestic companies to provide all the necessary answers in August, quite unrealistic to be frank about it, but share buybacks, bonus dividends and an explosion in M&A announcements at the very least show there is a lot of (quiet) confidence on display.

And confidence, as every economist and central banker will assure us, is extremely important for financial markets and economies alike. Investors will be hoping inflation will prove transitory and governments will figure out how to deal with the virus, as with climate change.

Bottom line: the outlook for equities won't be solely determined by profits and dividends, but for the four weeks ahead they are nearly all that matters, with the general framework set for a genuine cash splash bonanza on the ASX. Incidentally, data accumulator FactSet reports the second quarter in the US is generating the best outcomes on multiple metrics since FactSet started its US corporate data series in 2008.

US share markets are in a similar position as the ASX: not cheap, but with strong underlying support, and with multiple serious question marks ahead, though few will question the resilience of the mega-trends in the background.

Dividends In Strong Up-Trend

When it comes to specific sectors and individual companies, the key difference between Australia and the US cannot possibly be more accurately illustrated as through Rio Tinto's ((RIO)) super-dividend announcement last week.

As the shares are essentially trading on a double digit yield percentage, because the market doubts iron ore priced above US$200/tonne is sustainable, Rio Tinto's half-yearly payout amounts to a 5%-plus cash distribution; or what shareholders pre-pandemic came to expect from their beloved banks is now being paid out over six months only, with more to follow.

The yield on Fortescue Metals' ((FMG)) dividend in August should be even higher, while a more diversified BHP Group ((BHP)) should still pay out more than each of the banks this year.

Sure, there is every chance this year marks the peak in payouts for these companies, but it remains an open question how long iron ore prices keep feeding into excess capital and exactly how quickly the transformation to a more normal payout will ensue for the sector.

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