The current round of earnings releases is winding down, with healthcare provider Sigma Pharmaceuticals (SIP) the last to report on 14 March. After that we can all catch our breath – until mid April when the banks begin weighing in with their results.
Earnings season should be an exciting time for investors for a variety of reasons. Hard financial results can serve as supporting indicators for prophecies of doom or gloom for the company, the sector, the Australian economy, or global macroeconomic conditions.
In many cases share price declines post earnings provide buying opportunities for both growth and value investors.
Another less obvious reason is a reality check on analyst recommendations.
Regardless of how well-trained they are or the pedigree of the investment firm for which they ply their trade, analysts are only human. Checking recent analyst recommendations sometimes provides valuable insight into what to expect from an upcoming earnings release.
The most common source for investors are the abbreviated research “notes” or “recommendations” you find on many Australian financial websites, including TheBull.com.au. Typically these are broad conclusions reached by the analyst without going into specifics.
Let’s take a look at four companies that reported Interim or Full Year earnings in the final week of February 2013, along with Sigma, the first to report in March.
Here is our table:
2 Year Earnings Growth Forecast
On 31 January 2013 Woolworths (WOW) reported its Half Year Sales Results for 2013. Half Year Earnings Results were released on 28 February. Woolworths saw revenue increases in all operating segments with the exception of a 1.2% decline in petrol sales. Total group sales increased 3.2% while revenue from continuing operations rose 4.8%. The company got out of the consumer electronics business during the second quarter of 2012. The largest percentage sales increase came from the Home Improvement segment with a rise of 54.6%.
The sales results prompted updated notes from seven of Australia’s major brokers, none of whom changed their prior recommendations. JP Morgan raised its price target from $32.50 to $32.83 and forecasted a 4.4% increase in underlying profit to be released at the end of February. Morgan also expected the company’s Food & Liquor margins to remain flat. Overall analyst reaction was underwhelming, with Deutsche Bank expressing moderate disappointment with the sales results and UBS lowering its FY2013 forecasts.
Woolworth’s share price is up close to 40% year over year but dipped a bit going into earnings. The company’s Half Year Results beat expectations and management raised its FY 2013 guidance to a range of 4-6% while acknowledging conditions are still challenging.
Net profit after tax rose 5.5% and when one off items from the divesting of the consumer electronics division are included the increase jumps to 19.4%. Perhaps the biggest surprise was the healthy increase in Food and Liquor margins which were expected to remain flat but came in with an increase of 7.7%. Here is a one month share price chart showing the pre-release trading and early results of the post-release market reaction:
The most recent major analyst recommendations for Treasury Wine Estates (TWE) going into earnings were a SELL rating from Deutsche Bank; an UNDERPERFORM from Credit Suisse; and an UNDERWEIGHT from JP Morgan. Prior ratings from late 2012 were equally unenthusiastic with an analyst at Macquarie stating there’s nothing exciting in the near term for TWE, although the company does have an internationally successful branded wine with its Penfolds line. The company’s cited problems range from bad weather driving down expected grape yields, recessionary conditions in Europe, questionable growth in the US to the stubborn strength of the Australian dollar.
Despite these challenges the company’s share price has remained positive year over year and was up close to 25% going into earnings, another fact cited by analysts as such high valuations are another reason not to like this stock.
Earnings results came in as expected with a 23.2% drop in earnings before material items and SGARA (self generating and revolving assets). Earnings decline was worst locally, with a slide of 25.5% in the Australia/New Zealand markets. However, the Asia region saw an increase of 12.5%. Another positive was an effective cost control program that resulted in an impressive 7.7% drop in the cost of doing business.
Treasury’s results are a good example of the confusing nature of earnings reporting. A reported 30.2% increase in NPAT may explain the share market reaction to the numbers. Here is a one month chart for TWE
The share price advanced 8.2% to move the stock up to a 36% year over year gain. In a 01 March note an analyst at CIMB securities observed that nothing has changed in Treasury’s basic story. The discrepancy between the 31% NPAT reported increase and the NPAT before adjustments loss of 23.1% has to do with material items relating to the 2011 spinoff from Fosters and the SGARA net loss of $15.5 million from market price changes in the value of the company’s California grapes. What happened was the 2011 numbers were down due to these one-off charges in that accounting period making the comparison artificially inflated.
Company management reaffirmed its guidance and highlighted its substantial investment in land purchases and new plantings to drive sales of higher margin wines. The company is aggressively looking to expand its Asian presence, especially in China. With 54 brands in its portfolio, Treasury Wine may have a bright future but the nature of its business is fraught with risks.
Based in the UK, Henderson Group (HGG) is a global fund manager offering a wide range of investment options for institutional, high net worth, and retail investors. Products include equities, fixed income and property investments, hedge funds, and private equity investments. The company benefits from high margin fund inflows in the face of declining interest in equities and also benefits from improving international equities market performance.
Going into its Full Year Earnings release Henderson Group was upgraded to BUY from NEUTRAL on 22 January 2013 at Citi. The broker also raised the target price from $1.80 to $2.60, citing improving global equities markets. On 21 January 2013 UBS maintained its BUY rating despite a rally that saw the stock price rise from $1.70 in November of 2012 to $2.50 in mid February of 2013.
The actual results showed an 8% drop in underlying profit and a 6% drop in earnings per share. On the positive side the company maintained its healthy operating margin of 36% despite the profit fall. Management attributed the decline to the volatility of trading markets in mid 2012 and high exposure to Europe in particular and equities in general. Here is the company’s share price performance going into earnings and the immediate reaction of share market participants:
This is another example of the importance of what gets reported to the general market. RTT news and others reported numbers reflecting the magic of accounting with net profit before tax – not underlying profit – rising from 13 million pounds in 2011 to 96.2 million pounds in FY 2012 and NPAT rising to 99.9 million pounds from 33.9 million pounds. .
On 01 March UBS downgraded the stock to NEUTRAL based on valuation, not performance. In fact, the analyst stated more reason for optimism after the earnings release. BA-Merrill Lynch agreed and chimed in by maintaining its prior BUY recommendation citing improving European business in Q4 of 2012. However, BA did lower its price target from $2.65 to $2.55.
Analysts at JPMorgan Chase raised their target price from $2.46 to $2.77 while Credit Suisse raised their target to $2.73 from $2.38. Espirito Santo Investment Bank Research, based in Portugal, downgraded the stock to NEUTRAL, reducing the price target to $2.15 from $2.21.
Wotif Holdings (WTF) is an Australia based online discount travel accommodations booking service. WTF controls 35% of the Australian market. Acquisitions have expanded Wotif’s reach into complete travel packages, as well as individual flight and car rental bookings. The strong Australian dollar and consumers’ tightening their wallets present major challenges to Wotif.
Going into earnings, JP Morgan expressed positive views on the company’s new CEO, Scott Blume, citing his experience with an Indonesian online hotel booking service as a help to Wotif’s expansion into Asian markets. In a 23 October 2012 recommendation note, Deutsche Bank lowered its price target to $2.00 from $2.15 while at the same time expressing optimism for short-term earnings growth stemming from Wotif’s decision to raise its commission fees.
Other analysts expressed concern about Wotif’s share price appreciation. In mid January the company’s share price was up 30% year over year. However, the share price began to quake in early February and the Interim earnings release on 27 February sent the stock plummeting. Here is the one month chart:
Total revenue dropped 1%; NPAT dropped 5%; and EPS dropped 5%. The extreme negative reaction here could be explained by the fact that at its recent Annual General Meeting, management suggested the interim results would be “flat.”
Credit Suisse downgraded the stock to UNDERPERFORM from NEUTRAL, lowering its price target to $5.40 from $6.10. The analyst suggested the market had overestimated the potential impact of the earlier price increases, bidding up the stock too high. Macquarie expressed a similar view about the rise in commission prices driving up the stock. An opposing viewpoint came from CIMB Securities where the price target was raised from $5.40 to $5.85 with the analyst still positive about the growth potential from raising commission rates.
So what does the future hold for the last company to report this quarter, Sigma Pharmaceuticals? Sigma is a company in transition, after its 2005 merger with Arrow Pharmaceuticals, a move meant to expand the company’s reach into the manufacture of generic drugs. The move did not pay off and Sigma divested itself of Arrow, finalising the deal on 31 January 2011. The company is now focused solely on its wholesale pharmacy distribution business. It has two highly recognised brands in Guardian and Amcal.
On 20 December, 2012, a Deutsche Bank analyst expressed confidence that Sigma would deliver strong earnings growth, but not until FY2014 as Sigma works to drive down operating costs and grow sales. In October 2012 the company agreed to settle a class action lawsuit, leading an analyst at Credit Suisse to state that the settlement removes funding as an issue, leading to a “good buying opportunity.’ Credit Suisse has an OUTPEFORM rating on Sigma.
However, UBS expressed the opinion the settlement could negatively impact Sigma’s debt outlook and JP Morgan expressed concern the settlement could impact Sigma’s dividend yield. UBS had a SELL rating on the stock as of 25 October, 2012 and Morgan had a HOLD recommendation.
Sigma may be one to watch as the company’s stock price has underperformed the overall ASX XHJ Health Care Index. Here is a one-year price chart comparing Sigma against the XHJ:
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