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Highlights of the reporting season

October 2016

By Antares Equities

Profit growth was weak across the board

Aggregate market profits were down 5% year-on-year in the six months to the end of June 2016.  There was weakness across the market, with banks, industrial companies and resources posting negative aggregate profit growth for the period. In particular:

  • banks’ earnings fell, mainly due to lower non-interest income and a modest rise in bad and doubtful debts
  • resource stocks were down 25% for the six months – but this was an improvement on the 70% fall in the previous six months. The recent upswing in commodity prices was a significant driver of the earnings improvement, and
  • industrial stocks – about 55% of the market – were a mixed bag.  Cyclical or ‘value’ type companies delivered marginally positive aggregate earnings growth, while defensive stocks’ earnings growth was negative. Among defensive stocks, significant earnings disappointments were Woolworths, QBE Insurance Group, Telstra Corporation and CSL.
Positive surprises were few and far between

There was very little positive news for investors. Only five companies delivered both better than expected sales and earnings and upgraded guidance: Fortescue Metals Group, Seven Group, GWA Group, JB Hi-Fi and Mayne Pharma Group.

In terms of themes, companies that delivered solid earnings results were:

  • housing and apartment boom: Mirvac Group, Stockland, Fletcher Building, Boral and Lendlease Group
  • domestic consumer spending: JB Hi-Fi, Harvey Norman, Nick Scali, Baby Bunting, Fantastic Holdings
  • growth of the Chinese consumer: Treasury Wine Estates, Sydney Airport, and
  • trend towards higher electricity prices: AGL Energy.

Several large sectors announced disappointing earnings and experienced earnings downgrades. These included insurance, telecoms and healthcare.

‘Value’ stocks are coming back into play

A key feature of the reporting season was the outperformance of ‘value’ type companies that delivered earnings results that met or slightly exceeded expectations. They included GWA Group, Downer EDI, Ansell, Computershare, Sims Metal Management and BlueScope Steel.  Generally, the good performance of value stocks was because investors had low expectations and the stocks were trading on relatively cheap valuations. This meant even small positive surprises caused significant share price moves.

The big question for investors is whether this improved sentiment towards ‘value’ stocks marks an turning point that leads to a change in market leadership. Chart 1 shows the relative performance of different sectors of the market since 2008. Cyclical companies have underperformed defensives for many years as their earnings have been constrained by weak growth. The uncertain market environment and historically low interest rates globally have meant a strong investor preference for defensive and interest rate sensitive stocks. These defensive investments have been coined the ‘TINA’ trades (There Is No Alternative). They are very ‘crowded’ and vulnerable to a change in sentiment.

Chart 1: Relative performance of major market sectors

*Cyclicals comprise sectors within GICS Level 1 industrials, consumer discretionary, financials (ex banks, insurance, REITS) and materials (ex mining). **Defensives comprise GICS Level 1 consumer staples, health care, telecoms, and utilities. Source: MSCI, Datastream, Citi Research

The evidence in the August reporting season suggesting that cyclical stocks’ earnings are recovering is very important, as it may provide the investment Alternative that has been lacking in recent years. It has definitely reignited interest in ‘value’ stocks. If a turning point is in play and ‘value’ is re-emerging as a dominant driver of performance, it marks a significant change for investors.

Recurring themes – dividends and capital management

Two recurrent themes over the past few years have been strong dividends and capital management. The August reporting season was no exception. Macquarie Research data suggests around $70b was paid back to investors via dividends in FY16, well above the long-term average of around $54b.

The dividend payout ratio for ASX 200 companies remains near historic highs (Chart 2), mainly due in recent years to a strong rise in the payout ratio of resource stocks. Bank payout ratios have been relatively stable and industrials have experienced a much more modest rise (Chart 3). Companies are responding to the record low levels of short-term interest rates and bond yields that are forcing investors to find other yield-bearing investment opportunities.

Chart 2: S&P/ASX 200 dividend payout ratio

Source: Datastream, IBES, Deutsche Bank.

Chart 3: Dividend payout ratios – banks, industrials and resources

Source: Datastream, IBES, Deutsche Bank

The forecast fall in the FY17 payout ratio in Chart 2 is interesting – the chart is sourced from Deutsche Bank but is consistent with forecasts among other sell-side analysts. Is it a sign that the strong focus on dividends is set to wane in FY17 and beyond?  It’s unclear whether the high current payout ratio is just a cyclical trend in response to historically low interest rates or whether it also reflects a structural shift as the ‘baby boomer’ generation moves into pension phase and seeks out alternative yield-based investments.  Only time will tell, but investor appetite for dividends is unlikely to abate soon with interest rates so low and the dividend yield still relatively high. This suggests companies will continue to respond by returning capital to shareholders through dividends and high dividend payout ratios.

Company guidance cautious

Company guidance remained patchy and cautious given the uncertain global macro backdrop and the difficult domestic trading environment. Several companies mentioned slower activity in the final quarter of FY16, partly due to the drawn-out election campaign. Very few companies mentioned any improvement in trading conditions so far in FY17. Meeting current earnings consensus expectations for FY17 is likely to remain challenging.

 

The above information is of a general nature and has been prepared without taking account of your individual investment objectives, financial situation or particular investment needs. It is not intended as financial advice to retail clients. Before making an investment decision, you should consider the appropriateness of the information, having regard to your objectives, financial situation and needs. We recommend you consult with your financial adviser, who can help you determine how best to achieve your financial goals and whether investing in a fund is appropriate for you.

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