Stockpickers often get edgy around reporting season and rightly so – as this is the moment when companies must ‘fess-up’ their earnings for the six months to 30 June.

No one is expecting this reporting season to include as many shocks as last year’s litany of bad news – but underlying weakness remains. Market consensus expects a 22.7 percent fall in earnings per share (EPS) over financial year 2008-09.

Unsurprisingly, while a commodity price slump is expected to deliver an even sharper fall in resources – by 35 percent – earnings in the financials sector look set to fall by around 40 percent.

Industrials and materials sectors are forecast to fall by 40 percent and 30 percent respectively, but on the flipside, the energy sector is likely to be up by a corresponding amount. Likewise, healthcare looks set to report 20 percent-plus gains, and humble profit increases are on the cards for utilities and consumer staples.

Given that it’s projected to be the worst season for profits since 1990/91 when (EPS) fell 26 percent, August is shaping up to herald a mixed bag of numbers. And with much of the market still confronting significant balance sheet pressure, brokers expect reduced earnings to spell sizable dividend cuts, with Westpac (WBC) expected to join ANZ and National Australia Bank (NAB) in cutting its dividend by around 20 percent.

Capital preservation underscored last reporting season, but this time around – following the recapitalisation frenzy – there’s an air of optimism. Indeed, there’s weakness in the underlying numbers, but much of this is already factored into share prices. As many stocks are expected to outperform as those likely to disappoint against expectations.

EPS is under pressure this reporting season, but a Credit Suisse analyst report suggests that – with the plethora of stocks displaying medium-term upside – the market is looking attractive enough for investors to position for a financial year 2011 EPS recovery.

So with many brokers having BUY recommendations on no fewer than 40 percent of stocks covered, how can investors make money this reporting season, and what should they look for within the commentary?

According to Clifford Bennett Chief Economist with Kinetic Securities, investors looking for long-term holdings might be wise to buy their preferred stocks pre-result – possibly enjoy an ensuing rally – and then reassess if they want to buy more following the announcement.

He urges investors to lock-in their core holdings now, with the potential of receiving a share price kicker once fund managers pour back in. And assuming portfolios return to asset weightings that reflected historical norms, a whopping $100 billion will eventually be taken out of cash. “Once brokers get close to 70 percent BUY recommendations it will be time to start profit-taking as this will signal full-value recognition,” says Bennett.

He thinks that this reporting season is one time when retail investors can outsmart fund managers who misread both the ‘macroeconomic-led’ equity market rally and the March bottom. “We’re now in the stable part of a grand bull market, and while the bad news is fully priced in, the good news this reporting season is yet to be fully valued by the market,” says Bennett.

It’s equally important, advises Tim Schroeders fund manager with Pengana Capital that investors don’t fall into the trap of taking profit falls experienced by resource stocks this reporting season at face value. Given that commodity prices rallied strongly in March only to fall off a cliff 12 weeks ago, Schroeders recommends investors look beyond the numbers to the supporting commentary coming out of each stock.

And given that stocks delivering disappointing number this reporting season will be harshly dealt with, he says investors can hardly be blamed for wanting to review results first. As a case in point, Listed property trusts (LPTs) – which having raised $15 billion to shore-up dismal balance sheets – are about to report losses exceeding $7.3 billion. Macquarie Research Equities analyst Callum Bramah expects the sector to show an average 25 per cent drop in EPS. And while 95 percent of the largest trusts have already given earnings guidance, it’s valuations that could still surprise. So tread carefully here.

Interestingly, over 70 percent of stocks to report thus far have exceeded expectations on the back of cost reductions, a hunkering-down, and their ability to refinance. So given that many of these initiatives are unrepeatable, Schroeders says the key question for investors is how does that impact their quality of future earnings?

He expects the significant equity market recalibration that will follow this reporting season – aided by outlook statements and pending AGMs – means that come spring, investors should have considerably better insight into how individual stocks are travelling.

So what specific sectors and stocks do brokers think stock pickers should target and avoid?

With 1 percent GDP growth in fourth quarter 2009 likely to reignite excess consumption, Bennett favours the retail stocks, like Harvey Norman (HVN) and David Jones (DJS), and also expects manufacturing stocks, especially those making white goods to run hard. However, unless investors are prepared to cope with the underlying share price volatility these stocks may experience over the next three to six months, Schroeders says some investors may want to stay on the sidelines a little while longer.

But unless investors have an appetite for volatility, Schroeders warns against both cyclical and financials sectors for a least another three to six months. He also warns against re-entering bank stocks until the bad debt cycle plays out. “Scrutinise the level of ‘bad and doubtful’ debt being experienced by banks, plus their ability to manage the fortunes of their customer base,” advises Schroeders. “Given the huge recapitalisation experienced by the ‘Big Four’, the question now is – has it been enough to increase their tier one ratio, and ‘add-on’ acquisition requirements?”

And while bulk commodity producers are expected to hold-up relatively well, Schroeders expects the strong A$, and asset write-downs to create pesky headwinds for base metal and oil & gas stocks alike. “Given these currency headwinds, it’s important investors scrutinise the currency hedging deployed by both resources and industrial stocks,” adds Schroeders.

Identifying “earnings risk” will be a stock-by-stock story this reporting season, but Citi expects return on earnings (ROE) for contractors, stgelopers, engineers, plus some materials & transport stocks to come under increasing pressure as the outgoing tide of the former boom continues to retreat.

With this reporting season marking the absolute low for all stocks, Graham Harman equity strategist with Citi says it should give investors greater confidence to ‘shut their eyes and buy’ knowing that 2010 won’t be as grim. He says that given return on income has gone from 7 to 2 percent, this reporting season presents an opportunity to lock-in sustainable yield at around 7-8 percent on a medium-term basis.

In addition to the “big four,” his favoured yield stocks include Goodman Fielder (GFF), Metcash (MTS), and Tatts Group (TTS). He urges investors to favour the quality end of the LPT stocks – currently trading at chunky discounts to asset value – over anything offering a riskier 15-20 percent yield. And while there’s merit in waiting to see what pops up in the results, he also warns that a 6.5 percent yield from banks may not be around forever.

While Harman is cautious on resources due to commodity price volatility, he says  that – since market PEs have only risen from 10X to 15X – there’s still time to pick stocks well. “For a higher risk strategy, look for stocks in loss making or close to loss-making territory – rather than consumer discretionary stocks that have run hard – like those in the building materials sector or Qantas (QAN) – on the basis that the last of the bad news is starting to fade.”

Tips for capitalising on reporting season

•    “Early cycle” sectors to play in Australia include financials, media and REITs.

•    Accelerate shift to equities as signs of reflation emerge.

•    Listed Real Estate is attractive due to yields/valuations & leverage to economic recovery.

•    Look for value stocks to reassert their dominance over growth stocks.

•    Favour large-cap stocks over small-caps for reasons of ‘relative quality’

Source: Citi

 

Citi analyst earnings Result Expectations vs Consensus 

Above consensus

Company name (stock code)

AXA Asia Pacific Holdings (AXA)

Billabong International Ltd (BBG)

BHP Billiton Ltd (BHP)

Commonwealth Bank of Australia (CBA)

Coca-Cola Amatil Ltd (CCL)

Energy Resources of Australia Ltd (ERA)

Goodman Fielder Ltd (GFF)

Gunns Ltd (GNS)

Hutchison Telecommunications (HTA)

Harvey Norman Holdings Ltd (HVN)

Leighton Holdings Ltd (LEI)

Rio Tinto Ltd (RIO)

SAI Global Ltd (SAI)

Seven Network Ltd (SEV)

Santos Ltd (STO)

Wesfarmers Ltd (WES)

Woolworths Ltd (WOW)

Wotif.com Holdings Ltd (WTF)

 

Below consensus

Company name (stock code)

Bendigo and Adelaide Bank Ltd (BEN)

Boral Ltd (BLD)

Brambles Ltd (BXB)

Cabcharge Australia Ltd (CAB)

Challenger Financial Services Group (CGF)

Consolidated Media Holdings Limited (CMJ)

David Jones Ltd (DJS)

Emeco Holdings Ltd (EHL)

Foster’s Group Ltd (FGL)

Mirvac Group (MGR)

Pacific Brands Ltd (PBG)

Paladin Energy Ltd (PDN)

PaperlinX Ltd (PPX)

Qantas Airways Ltd (QAN)

QBE Insurance Group Ltd (QBE)

Sims Group Ltd (SGM)

Stockland (SGP)

Toll Holdings Ltd (TOL)

United Group Ltd (UGL)

WorleyParsons Ltd (WOR)

 

In-line with consensus

Company name (stock code)

Amcor Ltd (AMC)

AMP Ltd (AMP)

Arrow Energy Limited (AOE)

ASX Ltd (ASX)

Alumina Ltd (AWC)

Computershare Ltd (CPU)

Crown Ltd (CWN)

Downer EDI Ltd (DOW)

Elders Ltd (ELD)

Fortescue Metals Group Ltd (FMG)

Fairfax Media Ltd (FXJ)

Hastie Group Ltd (HST)

Insurance Australia Group Ltd (IAG)

Iluka Resources (ILU)

IRESS Market Technology Ltd (IRE)

JB Hi-Fi Ltd (JBH)

Newcrest Mining Ltd (NCM)

Oil Search Ltd (OSH)

OneSteel Ltd (OST)

Perpetual Ltd (PPT)

Ridley Corporation Ltd (RIC)

SEEK Ltd (SEK)

Spotless Group Ltd (SPT)

Suncorp-Metway Ltd (SUN)

Telstra Corp Ltd (TLS)

Tatts Group Ltd (TTS)

Woodside Petroleum Ltd (WPL)

Wattyl Ltd (WYL)

Source: Citi Investment Research and Analysis

 

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