Deciphering Earnings Reports

For many investors checking out full year financial results is akin to a return to the days spent as the “kids in the candy store” with some money in their pockets.

The question for the kids was the same as the question for adult investors – what should I buy and what should I reject?

Like the candy manufacturers, virtually all publicly traded companies will try to present the most positive picture possible of their financial performance. Financial regulatory agencies require truth in reporting, but that doesn’t stop companies from spruiking their results as best they can, even if less than spectacular.

For investors of all strategies – from value to growth to momentum – earnings reports have decided advantages over other means of making the decision to “buy, hold, or stay away.”

First, earnings reports are scheduled, giving investors ample time to prepare.

Second, there is no shortage of detailed information on what to look for in an earnings report, in order to decipher the components of the report.

The commonsense assumption underlying the vast majority of such advice pieces is this — if the company meets or exceeds its earnings target the stock price will rise. The converse is deemed to be true as well.

The “blow by blow” analysis of how to interpret income statements, balance sheets, and cash flow statements can be helpful, but all these are backward looking at a company’s performance for the year. For the future, most market education articles tell investors to look to the Management Discussion and Outlook statement and management guidance.

Far too often, those discussion statements center on how the results for the year were achieved. There is no legal requirement for the statement to include anything beyond a general view of market conditions, with no specific guidance for the company.

Investors who have followed share prices following earnings releases know the commonsense view that positive results lead to positive share price increases is wrong in many cases.

Some recent earnings releases supports that view. JB HiFi (JBH) reported Full Year 2021 earnings on 16 August. The company reported double digit growth for both “top line” revenues and “bottom line” profit, in addition to an 18.9% increase in its dividend payment. Net profit after tax (NPAT) was up 67.4%.

The stock price rose for only one day before settling into a steady decline on 17 August.

There are two likely explanations. First, buried on page 30 of a 39 page release was a trading update showing double digit declines in sales in Australia for Q1 of 2022 to date (from 1 July to 15 August.)

In addition, the company noted continuing concerns about COVID 19 made it appropriate for JB HiFi to refrain from posting any guidance for the Full Year 2022.

Another possible reason is some recent developments in the “Amazon invasion.” Investors and many analysts alike were impressed that JBH weathered the initial entry of Amazon into the Australian market. Amazon is flexing its muscles, with the completion of the largest warehouse in the southern hemisphere by the end of 2021. The Sydney warehouse reportedly can hold more than 11 million items, with the capability of sorting 25,000 items per hour. The Sydney warehouse will be Amazon’s first here powered by robots and 1500 workers.

In the case of JB HiFi the key for investors to decipher the report was not the historical numbers, but the possible downtrend detected at the start of FY 2022. Couple that concern with the spectre of Amazon detected by investors savvy enough to follow competitive threats and JBH looks like a “stay away” or a “watch and wait” at the present time.

The goliath of the Australian telecom sector, Telstra (TLS), provides another case supporting the view investors should focus on growth outlook in the report rather than latching on to the financial metrics.

The company reported on 11 August, with an immediate and lasting boost in the share price.

The financials for the year were borderline abysmal.

• Revenue down 9.1%
• Total income down 11.6%
• NPAT up 3.4%
• Underlying EBITDA (earnings before interest, taxes, depreciation, and amortisation) down 9.7%.

With numbers like that how could the stock price rally?

For part of the answer, Telstra had accurately predicted its downturn, so those results matched the company’s guidance for the year.

Another answer appears early in the report in the opening Chairman and CEO’s Message. In a section entitled “A Turning Point” management called FY 2021 a turning point with the company crawling out from under the shadow of the NBN (national broadband network).

The statement points to the headwinds stemming from the yearly transfer of some of the company’s assets to the NBN. The startling cost, according to management, was an up to $800 million dollar decline in EBITDA over the past four years.

In 2018 the company embarked on a strategic transformation strategy called T22 to combat both the encroachment of the NBN and rising competition.

Management expressed high confidence in the success of its T22 strategy and issued EBITDA guidance for FY 2022 of between 4.5% and 9% growth, with total income up slightly at $23.6 million dollars.

Hearing implant provider Cochlear (COH) is another ASX stock whose share price movement following the FY 2021 Financial Results announcement seems at odds with the performance.

The company set a record with reported revenue of $1.497 billion dollars, up 10%. Implant units were up 15%. Underlying net profit of $237 million dollars was up 54%. Cochlear’s final dividend payment was up 59%.

Guidance can’t account for the collapse in the share price, as Cochlear issued guidance of underlying net profit growth in FY 2022 of between 12% and 20%.

The share price might recover once investors look beyond the fact as good as the report was, it missed expectations set by major analyst firms like Goldman Sachs. The consensus analyst forecast for NPAT was $245.5 million dollars, about $8 million above the reported result.

While the company has a two year earnings growth forecast of an increase of 18.7% along with an increase of 17.7% in dividend payments, some investors may be reacting to a cautionary note from Cochlear management included in its guidance statement. While the guidance considers “some near-term COVID 19 impact”, management went on to warn that “a more material disruption from COVID remains a risk factor that does not form part of guidance.

Omni channel retailer Adairs (ADH) posted record sales in FY2021. Total sales increased 28.5% while underlying profit rose 101%. Investors enthusiastically drove up the share price early in the day, only to reverse course into the close.

Adairs is a specialty retailer with both online operations and brick and mortar stores selling homewares and home furnishings in Australia and New Zealand. In addition, the company now operates Mocka, an online only distributor of home and living products. Mocka designs some of its products in the Home Furniture & Decor, Kids and Baby niches.

The company listed on the ASX on 30 June in 2015, closing its first trading day at $2.66 and has risen 38% since.

Investors may be reacting to a trading update for the period from 30 June 2021 to the time of the release, with total sales for the two operating entities down 16.1% compared to the same period in FY 2021.

Investors may be ignoring the fact it is store sales that are down – 21%. Online sales on Adair websites are up 12.9% while Mocka’s online only sales are up 16.1%.

Given the lockdown situation, Adairs management “did not think it appropriate to issue FY 2022 guidance, given the ongoing uncertainty relating to COVID 19.”