Weekly Broker Wrap: Earnings Season Is Heading Your Way

This story features QANTAS AIRWAYS LIMITED, and other companies. For more info SHARE ANALYSIS: QAN

-$A a bright spot this earnings season
-Best recovery seen in domestic cyclicals
-FY14 pivotal for electricity retailing
-NSW best placed for residential recovery
 

By Eva Brocklehurst

Earnings growth for the aggregate Australian market is expected to be fairly flat, or up around 5% excluding resources, when companies start releasing their profit results in coming weeks. UBS reports consensus estimates have eased from the 3% improvement, or 6.5% excluding resources, that was expected six months ago. Stock-specific profit warnings have increased but a number of passive Australian dollar upgrades for those earning foreign income have kept aggregate earnings estimates from deteriorating even further.

Last reporting season there were a number of rallies in "value" stocks which published better-than-expected results. This time around investor expectations are subdued and a weakening economic backdrop is not expected to provide the same crop of rallying stocks. UBS analysis has the expectations ratio for individual stocks surprising on the downside skewed three to one. The weaker Australian dollar is expected to provide one of the few bright spots in the season. Plus, there may be some tentative improvements in the housing construction cycle. The broker notes the downgrades have come thick and fast recently but the market appears to have been willing to reward currency-driven upgrades alongside operational upgrades.

Looking further afield, FY14 consensus earnings growth for the market, excluding resources at 8.8%, seems a stretch to the broker. Hence, UBS sticks with a top-down forecast of 6% given forecasts of further softness in the Australian dollar and the focus on improving corporate efficiency. UBS does not factor in much in the way of either economic improvement or deterioration. 

Goldman Sachs is more optimistic than many brokers on the outlook for company earnings, expecting 10% earnings growth for the ASX200 in FY14. This should be driven by 15% growth in resources, 10% in industrials and 7% in financials. Risks may be skewed to the downside domestically, but Goldman expects the lower Australian dollar and improving global growth should more than offset the risks. Providing the encouragement is some recent production reports. These have highlighted stabilising prices and improving volumes.

Consensus forecasts show industrial sector earnings growth should accelerate from 6% in FY13 to 12% in FY14 and half of this growth recovery appears based on companies with significant offshore revenue. If this is the case, Goldman believes it could be even stronger. The broker has a 12-month forecast for the Australian dollar of US85c and expects US growth to accelerate from 1.6% in the second quarter of 2013 to 3.4% by the third quarter of 2014.

The greatest recovery is expected to be in the domestic, cyclically exposed stocks and key contributors to the rebound are to be found in the transport sector. These include Qantas ((QAN)), Asciano ((AIO)), Toll Holdings ((TOL)) and Aurizon ((AZJ), as well as building materials. Stocks that Goldman thinks may miss consensus revenue forecasts for the second half of FY13 are UGL ((UGL)), FlexiGroup ((FXL)), Harvey Norman ((HVN)), Cabcharge ((CAB)), GWA Group ((GWA)), Asciano, Pacific Brands ((PBG)) and SEEK ((SEK)). In FY14 the broker believes Sims Metal ((SGM)), Ansell ((ANN)), Computershare ((CPU)), Fletcher Building ((FBU)) and Amcor ((AMC)) are exposed to sectors and regions that are expected to recover, yet they each trade at a price/earnings ratio that is below market.

FY14 will be the inflection point for energy retailing, in BA-Merrill Lynch's view.With Origin Energy ((ORG)) ceasing door-to-door sales, churn will decrease and margins will likely stabilise as retailers attend to profitability. The upside for the industry is deregulation. Queensland is targeting FY16 and deregulation is under consideration in NSW. Merrills expects 2.6% profit growth for Origin in FY14. AGL Energy ((AGK)) is expected to be more subdued, at around 2% growth for FY14. Both energy retailers have been undertaking initiatives in recent months to rationalise costs but the broker does not think things will turn around that soon.

Origin is preferred by Merrills' because of the tangible milestones ahead in the next 12 months. These include QCLNG's start-up in mid 2014 and the potential sale of the APLNG pipeline for around $2.5 billion, which should substantially boost Origin's funding position. Merrills maintains that the carbon tax, CSG, and tough retail environment are at the forefront of concerns for AGL but this could all turn around in 12 months.

BIS Shrapnel expects the building activity the Australian economy craves as the mining boom dissipates will gather momentum in the next two years. It will be uneven. The Building in Australia 2013 report author, Kim Hawtrey, has observed home construction, in particular, has not responded as expected to the reduction in interest rates. These should be more stimulatory, but this is being hampered by high household debt, concerns about the global economy, planning restrictions and a lack of land in some states.

The report predicts that residential building will show little overall growth in 2013/14, with gains in some areas matching losses in others. Residential markets are expected to improve in NSW, Queensland and Western Australia where population growth and stronger economies will allow home building to respond to rising stock deficiencies. Each of these states has an estimated dwelling deficiency and recovery will be driven by upgrade/downsize demand and investor demand, including from overseas. These factors are most likely to promote improved confidence and new residential building in NSW. 

In contrast, Victoria and the other southern states will likely contract. This is considered inevitable following several record years of home building in Victoria. This market is now in oversupply. Dwelling commencements are forecast to contract by 2% in 2013/14. Better overall housing growth should come in 2014/15, by 9%, and 2015/16, by 4%. Moderating the upturn will be a continuation of the caution, affordability barriers, unemployment concerns and high household debt levels we have become familiar with.

Non-residential building is expected to strengthen in 2013/14 as the private sector supports new projects. After that BIS Shrapnel expects a retracement for three years, as a number of large hospital projects fall from the figure. Only by 2017/18 is growth, around 3%, expected to return. Social and institutional building starts are expected to decline in the medium term as governments cut back spending. Commercial and industrial building are also expected to weaken. After a 7% rebound in 2013/14 non-dwelling building is expected to peak at $33.5 billion and not surpass this level for the next five years. So, for commercial and industrial building there is a brief good year in 2013/14 before it all dries up again.

Delving into Australian household debt ratios, Commonwealth Bank analysts have found these are relatively high by international standards. What is important is understanding the economic and social characteristics of the households that have the debt. Official data such as the HILDA report has indicated that household debt increased steadily over 2002-10, mainly for housing. Households which carry the most debt are typically stable. They are couples with good health, high education and relatively high and stable incomes. Hence, they are in a good position to service the debt. Net assets are also important in judging capacity to cope with adverse economic developments.

Commonwealth Bank analysts observe that one of the interesting recent trends is for households to increase housing debt repayments over 2012-13, by leaving repayments unchanged as interest rates fell. This is in line with the general inclination to reduce housing and credit card debt that has been taking place since the GFC. This cautious behaviour has provided households with an important buffer to negative economic shocks. The analysts conclude that commentary about balance sheets, which conveys an impression that household debt levels are too high and householders are at risk of financial ruin if economic circumstances change adversely, is not borne out by the studies or data.
 

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