3 sectors (and 6 stocks) to watch out for this August reporting season

August is just a few weeks away and that means it's time for another round of full-year earnings reports from most of the 2,000+ ASX constituents. Six months ago, the story was one of earnings beats but problems beneath the surface. Cost pressures, supply chain issues, and rising rates all had an impact on corporate books.

But as Michelle Lopez of abrdn. pointed out in her February earnings wrap, cash flows are also changing - and so is the market's sentiment around a litany of companies that performed well through the pandemic. 

So what has changed and what can we expect to change over the next five weeks? This wire and video interview will attempt to answer those questions, with the help of James Gerrish of Market Matters.

Note: This interview was recorded on the afternoon of Wednesday, 13 July.

Big dates, big highlights

Before we go on, I figure it may be helpful to have a quick calendar of the biggest names reporting each week:

Week 1: Resmed (ASX:RMD), News Corp (ASX:RMD), Block (ASX:SQ2)

Week 2: Commonwealth Bank (ASX: CBA), Telstra, (ASX: TLS), James Hardie (ASX: JHX)

Week 3: BHP, CSL, Woodside (ASX: WDS), Santos (ASX: STO), Treasury Wine Estates (ASX: TWE), Cochlear (ASX: COH)

Week 4: Northern Star (ASX: NST), Coles (ASX: COL), Woolworths (ASX: WOW), Qantas (ASX: QAN), Wesfarmers (ASX: WES)

The big picture on what to expect

No two days will be the same, is James' motto for August. Over the next four weeks, he says he is looking to see a lot of variation and uncertainty in ASX companies.

"The forecasting on one side is difficult, so we haven't seen a lot of analyst revisions leading up to it. When uncertainty is high, they tend to sit on their hands." James says. 

That uncertainty appears to not just be high but also widespread. Of the 47 ASX quarterly or interim results since March, FNArena tabulated that there were 14 stock upgrades and 13 stock downgrades as a result. Having said this, James isn't worried about the non-moves from analysts. He says the market's done a lot of the work for them.

"There's still a fair amount of room for them [to make moves]. We're probably priced for a recession," James says.

"To me, I think that earnings season will be a lot better than what the market is positioned for."

High uncertainty means a continuation of restricted visibility for specific companies and, in some cases, whole sectors. James says it's all going to come down to nuances between companies.

"I think there will be some big moves at the stock level. It's going to be the nuances on how companies are managing the uncertainty that really counts," James adds. 

So are expectations too high?

In short, yes, James says. 

"I think we'll go into a period of earnings downgrade and re-rates to the downside," James says. This slew of heightened expectations is what's also supporting valuations. The big question will be if this trend can continue post-August.

"That's why we've seen an artificially depressed valuation in the market - but that'll change," James says. "You'll see a transition back to more normal multiples." 

The big issues this August

Numbers are great, but sometimes, the words tell a whole lot more of the story that markets will react to. James says this time will be quite different, given the economic backdrop. But when it comes to finding the nuggets that count, James says it's simply about the fundamentals.

"It's the nuances in the statement, and the quality of the balance sheets," James says.

Beyond the basics, James is looking for how the rising cost of capital will impact margins. 

"Not only have interest rates gone up, so too has the [credit] spread," James says. "That has a big impact on business models."

Of course, the macro uncertainty will also be near the top of the bill. Words are one thing, but James points out it's all about finding companies who will act on what they say they will do.

"Not just throw away lines about managing uncertainty, but proper things they are doing to handle supply chains, lock in supplies at costs, manage wage pressures ... real actions rather than hollow rhetoric," James says.

The outlook for dividends and income

This time last year, Morgans added up the total in declared dividends across the ASX 200. Between them, they paid out a monster $38 billion in distributions and payouts. 

Will it be this big, this good again? James says you can expect those payouts to increase modestly - 5% is his prediction. But if you're not in the miners or banks, then yield pickings will be even slimmer than they used to be.

"The yield of the ASX 100 is 4.85% - but if you strip out the miners, you get a yield of 2.7%," James says. That means nearly half of the expected yield is coming from the resources names. The silver lining is those income investors have many more options within the two big sectors for finding optimum yield.

"I wouldn't feel too sorry for income investors at the moment," James says.

The sectors and stocks that are set to surprise

Surprises in the investment landscape happen every minute of every day. But they are, arguably, most pronounced in August. That's because companies' numbers have to stack up against what the researchers and crunchers expect. Surprises can also be good as well as bad. 

For some idea of where to find the good surprises, James says it may be worth looking at sectors and stocks that are already in the market's bad books.

"You think about property, for one. There's a lot of armageddons built into property stocks, in my view," James says. "You've got the upside potential for distributions."

When it comes to the A-REITs, look to Dexus (ASX: DXS) and Stockland (ASX: SGP) as potential outperformers.

Retail is another space where James says investors may be pleasantly surprised given there's similar price action in those names. 

For earnings certainty and some forward guidance, even in these remarkable times, James says you can look no further than names like Metcash (ASX: MTS) and Wesfarmers (ASX: WES). Beyond the consumer names, look out for Transurban (ASX: TCL).

But James says don't expect many more of these guidance statements in the short term.

For any downside surprises, they come no bigger than the commodities sector. 

"Earnings are high so dividend expectations are high. I think there could be some disappointment on the dividends announced by resources, energy companies, and the like," James says.

Bonus: James' "most nervous" stock to watch

Finally, I challenged James to name the one stock that he is most nervous about heading into August. He delivered with Service Stream (ASX:SSM) - a company that he added the day of the interview's recording!

"When you've got a business that has lots of staff and margins are pretty slim, you have a lot of room for error in this environment," James says. "But I think it's got really good prospects from here."

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