Rudi's View | Aug 16 2023
This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA
August Results: Early Observations
By Rudi Filapek-Vandyck, Editor
From a general market sentiment perspective, the importance of the financial performance of CommBank ((CBA)) in Australia is pretty much self-explanatory. Not only is CBA the largest (premium) bank in the country, it is also the second largest constituent of the ASX200.
Last week, CommBank's FY23 financials proved slightly more resilient than most analysts had been expecting. Management and the board at the bank showcased their operational confidence by lifting the dividend for shareholders by 14% plus announcing a $1bn share buyback on top.
In sticking with the local tradition from the past two decades or so, when things get hairy for local banks and the economy, CommBank stands ready to show the world who's boss. Plus there's always the knee-jerk response to make sure loyal shareholders are pampered. CommBank's blueprint was also followed by minnow Bendigo and Adelaide Bank ((BEN)) on Monday (dividend up by 15%).
While questions remain about what exactly to expect from the year ahead given rate hikes impact at a significant delay and all that, CommBank's FY23 performance has injected enough confidence for most sector analysts to now project ongoing dividend increases for the years ahead.
This is a notable improvement from the weeks and months preceding this year's August results season when just about every analyst had penciled in one more rise for the dividend, followed by one year, maybe two years, of no further increases.
While the overall mood change post FY23 release is undoubtedly a positive, investors should equally keep things in perspective. Consensus forecasts now see CBA's dividend growing by 1.7% this year, and by 2.6% next – a far cry from the double digit pace that has characterised the years gone by.
Herein lays the challenge for investors this season: how good exactly is good news? CommBank's profits are still expected to remain under pressure, as they have been in the six months past.
The bank cautiously added to its provisions to cover bad and doubtful mortgages on the rise. Things are still expected to deteriorate first, before they can get better.
As we enter week three of the August season, Australian investors really only had a tiny taste of what is yet to come in the second half of this month. On Monday, the FNArena Corporate Results Monitor still only consists of 34 assessments when circa 350 are expected by early September.
The early signals are, yet again, remarkably positive with companies' sales proving relatively resilient amidst plenty of data and anecdotes suggesting households are increasingly financially challenged.
Comments by CommBank and some of the retailers (Myer, Nick Scali) suggest the true impact is only now starting to be felt, which potentially shifts true risks for disappointment to February next year, or even to next year's August depending on how slowly this process unfolds.
For the optimists among us, such an elongated trajectory equally opens up the possibility that rate hikes and inflation won't impact as much as we fear in 2023.
I'd be surprised, however, if the market overall doesn't adopt a safety-first approach in the short term given there's now a downward trend and nobody knows how long or how far it will stretch to the downside.
Note how CommBank shares have been unable to hold on to their gain post result release, though they are still trading above $100 and well-above consensus target (as is their habit).
Both market updates have raised confidence and forecasts, as also illustrated by a visible up-tick in consensus price targets for both since releasing financial results.
Both companies are cyclicals, leveraged to construction cycles locally and overseas, and both have had a challenging time in years past leading to multiple profit warnings and disappointments.
Confidence seems stronger for James Hardie which offers more exposure to North America, but strong gains on the day of reporting have since been replaced with gradual, persistent share price erosion.
In their slipstream, it's worth pointing out positive surprises to date have also been delivered by AMP Ltd ((AMP)), Cettire ((CTT)), and News Corp ((NWS)); all are share market laggards for whom expectations might have finally fallen deeply enough so that the path of least resistance leads such companies to finally beat forecasts.
That initial observation, however, needs to be complemented with the fact many of market laggards are still finding it rather tough to decisively reverse the momentum, as also proven on Monday with not so great financial updates released by Ansell ((ANN)), Aurizon Holdings ((AZJ)), Beach Energy ((BPT)), and Lendlease ((LLC)).
One early observation is cost inflation and margin disappointment are shaping up to become key features this August. This makes it extra-extra difficult to predict winners and losers beforehand.
And while aggregate dividends are forecast to fall, predominantly because the price of iron ore is no longer at dizzying highs, shareholders have already seen unexpected dividend disappointment from Coronado Global Resources ((CRN)), QBE Insurance ((QBE)) and Suncorp Group ((SUN)). Rio Tinto's ((RIO)) dividend was expected to fall sharply, but still missed forecasts.
On the opposing side, AGL Energy ((AGL)) surprised positively, as did AMP (assuming anyone still cares about the latter).
The number of companies reporting to date might be only a fraction of what is yet to come this month, ten of those already reporting are REITs or property developers. As expected, the warning signs are there: higher costs, margin pressure, and above all: higher costs to service debt.
The most precarious thus far seems Charter Hall long WALE REIT ((CLW)). A disappointing outlook, also weighed down by a higher interest burden, in combination with too much leverage on the balance sheet is now putting this REIT at risk of falling faul of its debt covenants next year.
Management at the REIT remains confident some assets can be sold, to alleviate the threat. Shareholders will be keeping their fingers crossed that confidence won't prove misguided.
As many experts have come to the view that global bond yields should have seen their peak for this cycle, it makes a lot of sense to carry at least some exposure to ASX-listed REITs, in particular since the sector generally is trading at sizeable discounts to asset valuations, up to -30% and more in some cases, while implied dividend yields can be as high as 7% and higher.
The problem remains these intrinsic discounts are the result of widespread uncertainty whether bond yields have indeed peaked and how much of asset re-pricing -devaluations!- needs to take place in the year(s) ahead. Meanwhile, darker scenarios for household spending would spell additional set-backs for many a REIT in Australia, including the potential for much sharper asset devaluations.
As per usual, there's no such thing as a risk-free lunch in financial markets and the more adventurous yield and value-seekers might have to be patient for (a lot) longer.
The former heavyweight in the local sector, Unibail-Rodamco-Westfield ((URW)) is now trading at a discount that boggles the mind; the gap between the share price and the valuation put forward by Morningstar/Ord Minnett is no less than -85%. If next year sees the return of dividends to the extent the analyst is forecasting, the yield at today's share price is in excess of 16%.
How much of today's discount is purely related to market sentiment? It's the crucial question for the owner of shopping malls worldwide that require lots of investments to remain competitive. Meanwhile, the balance sheet is burdened with a mountain of debt. Here too asset sales are part of management's strategy towards reprieve.
The FNArena/Vested Equities All-Weather Model Portfolio has exposure to the local REITs sector through Goodman Group ((GMG)), as the primus inter pares locally, and HomeCo Daily Needs REIT ((HDN)), which should prove resilient, while trading at a sizeable discount and offering dividend yield in excess of 7%.
One observation that usually applies each results season is the truly strong business franchises show their inner-strength, proving the doubters and the critics wrong by simply posting yet another strong set of financial metrics.
On Friday, REA Group ((REA)) did exactly that and on Monday Carsales ((CAR)) followed suit. Many an analyst expects Seek ((SEK)) to complete this triangle of strong results from online media platforms when it reports tomorrow (Tuesday).
Tomorrow's scheduling also includes CSL ((CSL)) and Pro Medicus ((PME)), so there's plenty to look forward to for investors who like to own the strong and the resilient. Apart from the usual debate about valuations, pretty much recurring every results season and in between, this year's general context is slightly different.
This time around Australia's number three index weight, CSL, has issued a profit warning beforehand to rein in analysts' expectations regarding its post-covid margin recovery, while also warning of negative FX impacts. With the share price not performing post covid, CSL has lost its halo, at least for the time being, and investors will be looking for clues as to where exactly those quality growth propects are hiding.
Things have become a lot worse very quickly for the number two in the local healthcare sector, medical device manufacturer ResMed ((RMD)). Having missed market forecasts by some -5% due to a lower gross margin in the June quarter, the market saw more reasons to sell after US pharmaceutical Eli Lilly announced a clinical trial to prove its treatment for obesity and diabetes can become an alternative for CPAP devices for people diagnosed with sleep apnea.
Given the enormous success of anti-obesity and diabetes treatments from Eli Lilly and Novo Nordisk, this surely means there's no viable business left for ResMed?
In simplistic format, that's one conclusion to draw from the rather savage sell-off in ResMed shares since August the 4th, but the situation on the ground doesn't seem that simple or straightforward.
A recent deep dive into this matter by healthcare analysts at UBS highlights that obese people with diabetes, the main territory for which the related treatments are being developed, only represent a small portion of your typical CPAP user. Certainly, both pharma companies will try to sell as many of their drugs to non-diabetics who simply want to lose weight, but this does not automatically impact on ResMed's audience or potential.
One of the key differences is governments the world around are prepared to subsidise an effective treatment for obese people with diabetes, but not for overweight people who simply want to lose weight. With costs running as high as US$1000 per month, and not lower than US$500/month in case insurers or employers jump in, the costs for today's popular lose weight remedies remain too high for most.
One outcome is most users stop using once they've achieved their targeted weight. Guess what happens next? The weight comes back on. There are also lots of side-effects, some very nasty, plus there is a percentage of the population for which these treatments remain without impact, i.e. they simply don't work for everyone.
Having done some research myself, I discovered stories about GPs in Europe who ban some of their patients from using these popular lose-weight treatments, because the side-effects are causing too much harm to their bodies. The most often mentioned longer-term effects are weakening bones and muscles disappearing, together with nausea, vomiting and diarrhoea in the here and now.
I see a similarity with increased competition for CSL's specialty products division from ArgenX's break-through treatment targeting people with severe autoimmune disease. Yes, it's an important development that should not completely be ignored, but at the same time all speculation about the death of CSL's growth path remain well outside the ballpark of plausible scenarios for the decade ahead.
Here's the response from Portfolio strategists at Wilsons this week:
"After downgrades for CSL and RMD, we believe now is an opportune time to buy two high quality stocks at very reasonable valuations.
"ResMed (RMD) – This is a rare opportunity to buy a world leading medical device company with a strong earnings outlook at a ‘cheap’ price, with RMD now trading at an FY24 PE of ~25x.
"CSL (CSL) – High-quality and defensive earnings with a growth recovery story (earnings CAGR of 20%). At an FY24 PE of 28x, a good buying opportunity for a quality long term compounder."
Other companies that have my personal interest this week include Amcor ((AMC)), Cochlear ((COH)), Goodman Group, HomeCo Daily Needs REIT, Netwealth Group ((NWL)), Orora ((ORA)), Steadfast Group ((SDF)), Telstra ((TLS)), and Transurban ((TCL)).
Bring it on!
FNArena Corporate Results Monitor
The FNArena Corporate Results Monitor is now updated daily: https://www.fnarena.com/index.php/reporting_season/
Given our assessment is not always in line with whatever label is used elsewhere, or with the share price movement post release, FNArena does on occasion receive questions to "please explain" from confused investors.
Here's one such attempt:
What determines whether a financial result is labeled as a 'miss', a 'beat', or simply as 'in line'?
FNArena takes a broad, holistic approach whereby we compare key financial metrics for FY23, compare them with forecasts, but then also include FY24 guidance.
Hence, if FY23 numbers are fantastic but the outlook disappoints, it's labeled as a 'miss' because markets are forward-looking and the future is more important than the past, all else remaining equal.
Our assessment also takes into account the gravity of it all. If a result beats by 1% or 2%, is that truly a "beat" or should we simply label it as broadly in line? Same question for when the 'miss' only looks marginal.
Some assessments are admittedly subjective when it comes down to write-downs, buybacks, tax rates, asset devaluations, etc.
Ultimately, a lot can be measured from how forecasts and valuations are adjusted post the financial results release. It's rather rare that a better-than-expected result leads to lower forecasts and reduced price targets. In similar fashion, a disappointing update will seldom see analysts raising their forecasts and valuations.
Hopefully this helps explaining our methodology.
Paying subscribers have 24/7 access to a designated section on the website on my research into All-Weather Performers:
A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.
(This story was written on Monday, 14th August, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: contact us via the direct messaging system on the website).
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