Earnings season: Cautious outlook statements to rule

Economic and financial markets events

Earnings season: Solid earnings should validate the level of Aussie share prices. The outlook is more complicated.

Profit results and outlook statements are pivotal in setting appropriate valuations for companies, sectors and the broader sharemarket.

Key period for listed Aussie companies

• Australia’s major companies are required to report on their financial conditions every six months. Of course some companies report on a more frequent quarterly basis to keep investors fully informed. The upcoming ASX deadline for quarterly results of companies with a June/December balance date is July 31 and the deadline for the half-yearly accounts and preliminary financial reports is August 31.

• Focussing on the S&P/ASX 200 index, most companies have a June balance date. In the last reporting season that ended February 28, around 140 companies that had a June balance date reported earnings with around 30 companies with a December balance date. The other ASX 200 companies have different balance dates.

• Solid earnings results are expected to be reported by major Australian companies, reflecting the ‘V-shaped’ recovery of the economy. In fact, profit estimates for ASX200 companies have surged to levels last seen in 2008, driven by a surge in iron ore prices, resulting in earnings upgrades for materials companies.

• But the recent lockdowns in Sydney and Victoria and rising cost pressures could prompt some industrials companies to issue more profit warnings than previously expected by investors ahead of the reporting season .

• Ccompanies again will justifiably keep cards close to the chest about the period ahead. While economies have rebounded quickly after previous lockdowns, investors are loathe to look too far ahead in these volatile times.

Conclusion & Outlook

• Earnings results in the next six weeks should justify current lofty valuations of the Australian sharemarket. The hard part is what comes next. Given the highly uncertain health and economic outlooks, we conservatively forecast the S&P/ASX 200 index to be in a range of 7,400-7,700 points by mid-2022.

Key discussion points over earnings season

• Outlook statements always feature prominently in earnings season. A month ago, many companies probably would have been reasonably upbeat. Suppression of Covid-19 had been reasonably successful across many jurisdictions. And there was the prospect of higher vaccination rates.

• But the Delta variant of the virus has been a game changer – both here in Australia and across the globe. So expect a high degree of caution to be exhibited by key personnel at listed companies.

• There will continue to be a big focus on supply chains – especially global supply chains. Not only in response to Covid-19 but also those companies affected by the trade restrictions applied by China. Investors will want to know whether diversification efforts begun, and how successful have they been.

• And then there is the issue of inflation, both higher raw material costs and the cost of goods affected by disruptions to supply. And globally as well as locally. Rising cost pressures could prompt some industrials companies to issue more profit warnings than previously expected by investors ahead of the reporting season

• Then there is the issue of employment. Are companies finding it hard to attract staff with Australia’s borders shut? What has that meant for wages? And has there been recourse to sourcing people from abroad with the company picking up costs of airfares, quarantine accommodation and local housing.

• One of the other focal points for Corporate Australia during the pandemic has been a surge in interest in takeovers. Some companies have opportunistically pursued rivals that have seen their share prices come under pressures due to Covid-related disruptions. Corporate Australia has seen a flurry of deal-making in 2021 with companies, super funds and institutional investors using lower interest rates to chase higher valuations. Several companies, including Sydney Airport and Crown Resorts have been involved in high profile mergers and acquisition activity (M&A).

• The S&P/ASX 200 dividend yield is now around 4.0 per cent, underpinned by franking credits. Payout ratios are expected to climb double-digits in percentage terms with Australia’s big four banks gearing up to pay out around $30 billion to shareholders. And more modest capital spending by miners and elevated commodity prices should enable producers to pay historically high mining dividend payout ratios.

Industry sectors

• Consumer discretionary, materials, finance and stay-at-home (information technology) stocks have out-performed in the Covid-19 environment. But utilities, energy, tourism, travel-dependent companies and some REITS have been buffeted. It’s been an uneven economic downturn and recovery.

• Companies dependent on foreign travel such as airlines and booking companies continue to face challenging conditions. Local lockdowns and the closure of foreign borders have buffeted services like hospitality, accommodation, arts & recreation and gaming operators as well as commercial and retail property businesses and toll road operators.

• In contrast, conditions for some miners and retailers have arguably been the best since the recovery period of the previous economic ‘emergency’ – the global financial crisis. Demand and prices for minerals are buoyant. And the Aussie dollar has been a benign influence, generally holding US68-80 cents over the last year.

• Solid retail sales have featured over the reporting period, especially on-line sales. Some retailers have continued to benefit from low or lower rents. Retailers in homewares, electrical or those focussed on delivery have out-performed. Companies that have a significant on-line presence (sales and distribution) continue to benefit from the investment.

• Energy companies will report improving conditions over the past 12 months. Both demand and prices have lifted over the period. But the Delta variant of Covid-19 has complicated the outlook at a time when vaccination rates have been rising across the globe.

• Banks will report solid demand for home loans and some lift in longer-term interest rates. But businesses remain cautious about taking on debt. And loan deferrals also continue to be offered amid persistent virus lockdowns. But operating conditions vary markedly across regions and across industry sectors.

• Healthcare operators, especially companies providing pathology services will note both higher revenues as well as higher costs due to strong demand. But the outlook is more complicated and harder to predict.

ADDENDUM

Last Reporting Season

Profits

• Of the 141 companies from the ASX 200 group that reported for the six months to December 2020, 121 companies or 86 per cent managed to produce a statutory profit (net profit after tax). To put this in perspective, over the past decade, on average around 88 per cent of companies have reported a profit rather than a loss.

• In aggregate (summing all the profit results), earnings were down 17 per cent on a year ago. Revenues fell in total by just 0.9 per cent, short of the 0.1 per cent aggregate lift in expenses.

Dividends

• In the six months to December 2020, 111 companies (79 per cent) elected to pay a dividend. If we go back to the full year to June 2020, only 68 per cent of companies elected to pay a return to shareholders. The average over the past 20 reporting seasons stands at 86 per cent.

• In aggregate, dividends were up 4 per cent on a year ago.

Cash holdings

• While companies elected to pay dividends again, they remained wary, with many choosing to hold more cash.

• Aggregate cash at hand (cash as at December 31) was up over 50 per cent on a year ago (up from $82 billion to $124 billion). Add in the companies reporting for the year to December and cash holdings stood at $166 billion.

• Overall 70 per cent of companies lifted cash levels from a year ago, notably retailers and banks.

The Big Picture: 2020/21

• Over 2020/21 the Australian economy experienced the sharpest recovery since the 1970s due to the relative success in supressing the COVID-19 virus as well as the speed and size of economic stimulus and support supplied by all levels of government and the Reserve Bank.

• Not all of the economic data for the 2020/21 financial year has been published. For instance the June quarter economic growth figures won’t be published until September 1. But it is clear that the economy has recovered strongly over the past year.

• In fact, at the end of March the economy was 1.1 per cent higher than a year ago. The jobless rate has fallen to a 10½-year low. The number of houses being built currently is at record highs. And activity gauges are at high levels with the NAB business conditions index in May only modestly lower than the all-time high set the previous month.

The Sharemarket in 2020/21

• The All Ordinaries ended the 2020/21 year up 26 per cent – the biggest rise for a financial year in 34 years. The ASX 200 ended the year up 24 per cent – a record financial year gain.

• The Consumer Discretionary sector out-performed over 2020/21. Consumer Discretionary shares rose by 42.6 per cent over the year, ahead of Information Technology (+38.9 per cent) and the Financials sector (+35.7 per cent).

• At the other end of the scale, the Utilities sector fell by 22.9 per cent while Health Care lifted by just 5.0 percent and Consumer Staples gained 5.4 per cent.

• Of the size groupings, the MidCap50 out-performed (+33.0 per cent) from the Small Ordinaries (+30.2 per cent). The S&P/ASX20 lifted by 26.8 per cent while the S&P/ASX50 recorded the smallest gain – up 22.4 per cent.

• Total returns on Australian shares (All Ordinaries Accumulation index) lifted by 30.2 per cent over 2020/21.

• The current historic price-earnings ratio (PE) stands at 21.11, up from the long-term average of 15.7 times earnings. The PE ratio has been near 21 times earnings since November 2020. In the past 40 years, PE ratios have hit 21 on three occasions, and then only briefly.

Published by Craig James, Chief Economist, CommSec