With the busiest week in reporting season now over, we reached out again to a group of experts for their view of the most notable results, both good or bad. Read on for highlights picked by David Sokulsky, Crestone Wealth Management; Ian Carmichael, Watermark Funds Management; Simon Shields, Monash Investors; and Alex Shevelev, Forager Funds.
The most notable result has been Domino’s
David Sokulsky, Crestone Wealth Management
Although Telstra had the most notable ‘company announcement’ during earnings season, the news was less about earnings and more about dividends. Additionally, it only impacted one company. As such, I think the most notable ‘earnings result’ and market reaction belongs to Domino’s Pizza. Domino’s reported net profit below guidance, blaming troubles on its roll-out in France for the poor result. As a result, the stock fell ~18% to two-year lows.
While the miss itself was notable, it was a very important result for the overall market and investors. It showed that there is significant risk when ‘growth darlings’ are priced to perfection. The market fell in love with Domino’s growth story and priced it accordingly at ~60x earnings. In conjunction with the results of REA and CSL, the Domino’s miss makes it unlikely that the valuations of ‘growth darlings’ will see such heady levels any time soon. Investors will be more discerning about valuation and this will impact on growth investors, mid-cap investors and those that believe that some companies are attractive at any valuation given the structural technology change currently underway.
Domino’s net profit was up 28.8% to $118.5 million. However, the market’s reaction to its result was very important as outlined above. It also reinforces the lesson for investors that good investments are different to good companies depending on the price you are paying.
Cardno on the right track
Engineering and environmental services business Cardno reported last week, with a recovery in the business showing some signs of taking root. Fee revenue rose 1% to $788 million while net profit after tax, adjusted for a set of messy one-off costs, rose to $19.9 million. The backlog, a health gauge for future work, rose 5% to $846 million. Net Debt, at just $15 million, is under control after the sale of a business unit during the year.
Cardno has had a chequered history. An acquisition binge starting in 2004 came unstuck in 2014. Debt ballooned, resources related expenditure declined sharply and the previous CEO departed. Enter Crescent Capital. The private equity firm has been involved in the business since 2015 and has underwritten two capital raisings as Cardno tried to stave off collapse. Crescent now own 47% of Cardno and their presentation at the last AGM brutally lays bare the failings of the past.
Their influence has been positive for the business over the past year. The Asia Pacific division continued to power along, delivering $30.1 million of earnings before interest, taxation, depreciation and amortisation (EBITDA) by taking advantage of some major engineering projects.
In the Americas the story is quite different, with margins still languishing at 1.6% and Trump’s $1 trillion infrastructure promise showing no signs of getting off the ground. This division is smaller than it needs to be to generate reasonable margins and management will be focussed on growing organically and through targeted acquisitions this year. The smaller International Development business showed a strong margin recovery in the second half of the year while Portfolio Companies, a grab bag of other businesses, has also contributed positively.
The Americas division will be the big swing factor going forward. With a forecast of $55 to $60 million of EBITDA for the 2018 financial year management is showing some confidence that the Americas division will improve margins. But with the stock price rallying sharply in the last year some of this turnaround is already being priced in; Cardno will need to execute to deliver on investor expectations.
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G8 Education delivers a solid earnings result
G8 Education (GEM) runs childcare centres, and head of the result, the market was concerned that increasing competition from new centres would cause falling occupancy rates and lower fees. But it produced a solid earnings result, generally in line, or above, analyst expectations. Occupancy is clearly important and was the only real weakness in the result. However, the result also showed that there is more than one driver in the business, with GEM’s strong cost performance expanding its EBIT margin. Encouragingly, management indicated that occupancy has improved over the last 3-4mths and that new supply has moderated.
One key feature of the result was capital management. GEM has now secured a ‘club’ debt banking facility from three Banks including two big Australian banks. This is a major endorsement, as up until now, GEM has been unable to secure debt financing from a top four Bank. GEM has also moved to a traditional dividend policy. This new debt facility and dividend policy now mean that GEM is self-funding business.
GEM’s operations produce positive revenue/expense jaws resulting in 10%+ EBIT growth. In this result, EBIT grew by 6%, or excluding the lumpy Government Day Care Funding, by an impressive 19%. Management has once again stated its goal of achieving $0.40 EPS by December 2019, which represents 17.5% compound EPS growth over the next 3 years. If achieved, this would see the share price perform strongly over time.
So, how serious is this target? Under GEM’s remuneration package, the long- term incentives are linked to compound rolling EPS growth. At more than 15% pa growth, all of the bonus is paid. And at less than 10% pa none of the bonus is paid. It is unlikely that a board would set, or that management would accept, a bonus target that they did not have a decent chance of achieving.
Critically, current consensus EPS forecasts for 2019 are $0.32 (20% below management’s target), and imply an EPS growth rate of 9%. If this were correct, then management would receive no long-term incentives. It is more likely that double growth in EPS will be achieved.
A closer look at Asaleo Care’s results
Ian Carmichael, Watermark Funds Management
Asaleo Care’s first half result this week stood out because of the fairly aggressive use of underlying profitability metrics. Early in the reporting period the company found that they had produced too much tissue inventory relative to market demand and so needed to make use of third party warehouses to store the excess inventory and even shut down one of their facilities for a period of time in order to allow the excess inventory to run down.
For the half year result Asaleo reported sales growth of 0.5% and an increase in underlying EBITDA of 4%, but if we adjust the underlying EBITDA number for the cost of shutting down manufacturing ($8.5m) and the use of third party warehousing ($1.1m) then EBITDA actually declined by 12%.
One reason the definition of underlying profit should matter to investors is because the company’s incentive plans are based on underlying measures of EBITDA and NPAT. If corporate profits decline because of mistakes within management’s control, should these factors be ignored when the time comes to calculate KPIs?
If investors are prepared to assume such mistakes were one-offs and unlikely to be repeated then Asaleo trades on an adjusted P/E of 13.5x. This looks an appropriate discount to the market given the structural challenges faced by the consumer divisions within the company, reasonably high debt levels, and rising pulp and energy prices in the second half.
You can see which four stock results were highlighted last week by clicking here
And you can see the three stocks highlighted the week prior to that here