After a strong rally will disappointment be the dominant theme this reporting season?
As I traditionally like to remind investors: every corporate results season has its own character and dynamics. The overall macro background, including index level and share price moves, plays an important role in understanding the overall context.
This time around, share markets have rallied, and rallied hard. In particular when we look back at the lows in September. That observation still stands if we simply measure returns year-to-date.
The past four-five weeks have witnessed an almost indiscriminate pickup in global sentiment, driven by macro-related drivers (inflation, bonds, central banks, China). While corporate earnings play a minor role when macro rules the day, at some point investors will be forced to zoom in, and price stocks accordingly.
This does not by default have to spell negative news, though there appears to be plenty of room to square off short-term results against further-out uncertainties. History suggests once share prices have had a strong run leading into corporate results, the balance of probabilities shifts towards 'disappointment' with the onus on management at the helm now having to prove why shares in the company should enjoy more upside.
Monday's interim result release by furniture retailer Nick Scali (NCK) seems to fit in with this thesis. Similar as with the likes of JB Hi-Fi (JBH) and Super Retail (SUL), Nick Scali's financial report delivered everything a loyal shareholder would want from its investment: strong profit growth, including at the EPS level, stable margins, excellent cost control and synergies kicking in from acquisitions.
Trading in January was so strong, it even took management at the firm by surprise. The dividend declared missed forecasts though, and there was no guidance for the second half.
Traditionally, companies that do provide guidance are being rewarded while those that abstain or move into non-quantifiable gobbledygook ("we see a bright future ahead") will trade at a discount to intrinsic valuation. On Monday, Nick Scali shares sold off by more than -13%.
The local reporting season has hardly started with the true tsunami in corporate releases only commencing from mid-month, but already there are plenty of signals suggesting the harsh assessment of Nick Scali's market release might well become a regular feature this season. Investors better sit up and take note.
The Opening Eleven
The first eleven ASX-listed companies to release financial updates thus far have mostly seen share prices weaken on the day.
First instant 'punishments' were reserved for ResMed (RMD) and Champion Iron (CIA), later followed up with similar responses to updates from Pinnacle Investment Managers (PNI), Credit Corp (CCP) and IGO Ltd (IGO), and, on Monday, Nick Scali, Imdex (IMD) and Dexus Convenience Retail (DXC).
The latter two can possibly be explained by the general risk-off sentiment on the day. Share prices weakened only slightly, while Credit Corp management somehow managed to reverse the initial response while chatting with institutional investors. Hence, the news is not as bad as it looks at prima facie.
This still only leaves three releases with an instant positive response, and only one shot the lights out: beaten-down asset manager Janus Henderson (JHG). Its share price is now trading 18% above FNArena's consensus target for the stock, with not one single positive rating from the brokers covering this company.
Centuria Office REIT (COF) and Centuria Industrial REIT (CIP), two bond-proxies that have had a challenging time over the past twelve months, have both enjoyed a positive market response post interim report.
The one common denominator for these early reporters has been cost inflation, more specifically: whether companies have been able to contain it, or not. The same eagle-eyed focus from investors was already apparent during January when small cap technology companies and commodity producers released quarterly trading updates.
The problem for both analysts and investors is this item is incredibly difficult to forecast. Add much higher share prices and it's not difficult to see why a healthy dose of caution seems but appropriate. Equally so: great companies with solid growth prospects might still disappoint short-term, offering opportunity for those who can look beyond the immediate market response.
Market Laggards & Forecasts
We've only had five weeks of trading in 2023 but already underlying signals and trends are markedly different from last year.
The 6%-plus gain for the local index in January -strongest calendar year opening since 1986- was, of course, carried by resources and banks, the two most important sectors for the ASX200.
In their slipstream major positive contributions have been delivered by Consumer Discretionary, Real Estate, Staples and even the technology sector; all clear laggards in the inflation and bond yields dominated market of 2022.
Small caps generally did not outperform the top end of the market, but here too many of last year's out-of-favour shares are back on the move.
Contrary to the US where the current reporting season is putting further pressure on forward estimates, in Australia consensus forecasts have been rising ahead of February. The number one segment responsible are miners on rising commodity prices and fresh China re-opening enthusiasm. No surprise here.
The number two segment responsible have been discretionary retailers a la JB Hi-Fi and Super Retail as Australian households did not hold back in December. Banks and insurers are still enjoying the spoils from (much) higher interest rates and bond yields.
In all three cases, there's plenty of scepticism around whether current positive momentum can carry into the latter half of 2023.
Elsewhere, forecasts are improving for media companies, healthcare, software and services, and utilities. The one negative stand-out is the energy sector where forecasts continue to deteriorate. As things are right now, this sector stands to enjoy a final hurrah this year, with sharp falls in profits and dividends on the agenda for 2024 and 2025.
Forecasts are already assuming the underlying trend for Materials, which combines bulk commodities with industrial and precious metals, is turning negative in FY23.
While current commodity prices suggest there could be more upgrades in store for mining companies, while forecasts for crude oil prices are not necessarily negative, one stand-out feature for the Australian market is that consensus forecasts essentially foresee no growth whatsoever post the 7%-plus anticipated for FY23.
That nil growth scenario for FY24-FY25 is made up of a marked improvement for healthcare, staples and utilities, with a relatively stable performance from real state (REITs) and struggles just about everywhere else. As said, the sharpest deterioration is currently forecast for the energy sector.
Forecasts are never set in stone, of course, certainly not this far out. However, the gap between early enthusiasm in January and what seems to be on the cards according to analysts forecasts seems quite profound.
Quant analysts at Citi, having conducted a detailed analysis of recent upgrades and downgrades in market forecasts, report analysts expect more positive earnings surprises from banks, REITs, building materials, retail and transport companies, with more negative surprises anticipated from metals & mining, healthcare and the travel sector.
One of the sectors that continues to polarise around covid-beneficiaries and re-opening plays is that of healthcare services in Australia.
As said, a robust quarterly performance from ResMed (RMD) did not please everyone, and questions remain around what'll happen with key competitor Philips from the Netherlands. ResMed, history strongly suggests, could well be one prime example of reporting season opportunity for investors confident in the longer term trajectory.
Certainly, general sentiment is improving for industry heavyweight CSL (CSL), as has also been apparent from the two updates on Conviction Calls published in January. CSL has been nominated by the team of healthcare analysts at Credit Suisse as a potential candidate to deliver a positive surprise in February, alongside New Zealand-based Ebos Group (EBO) which has been a solid performer since listing on the ASX in late 2013.
Credit Suisse sees rather mixed prospects elsewhere in the sector, with a negative bias for Healius (HLS), Australian Clinical Labs (ACL) and Ansell (ANN).
Peers at Macquarie have a sector preference for ResMed and CSL, with Cochlear (COH) and Sonic Healthcare (SHL) least preferred. Macquarie is equally cautious towards Healius.
Sector analysts at Citi also nominated ResMed and CSL, plus Fisher & Paykel Healthcare (FPH). Their preference is for product manufacturers over typical services providers, on less reliance on government funding and less exposure to stressed labour markets.
Citi points out Cochlear's second half might be negatively impacted by covid in China, but the analysts retain a positive view longer term.
Wilsons' Best Ideas
Wilsons' Best Ideas for the February reporting season also includes CSL, as well as Nick Scali. Clearly, the latter idea did not work out as intended with margins not increasing as was the anticipation.
Other Best Ideas are: Pepper Money (PPM), Austosports Group (ASG), Costa Group (CGC), PeopleIn (PPE), Family Zone (FZO), and ReadyTech Holdings (RDY).
Stockbroker Morgans sees risks for Ansell, Domino's Pizza (DMP), Ramsay Health Care (RHC), Credit Corp, Healius, Hub24 (HUB) and Inghams Group (ING) but also puts forward three so-called counter-consensus calls (where the broker is more confident than its peers): Blackmores (BKL), Helloworld Travel (HLO) and Qantas Airways (QAN).
When it comes to media companies, Credit Suisse ignores the traditional legacy businesses and concentrates on online platform businesses instead.
Credit Suisse very much likes Seek (SEK) and Carsales (CAR).
Among diversified financials, Credit Suisse sees upside for Challenger (CGF) and Perpetual (PPT) this month, and mixed dynamics just about everywhere else.
A negative bias has been placed on Computershare (CPU), Netwealth Group (NWL), Platinum Asset Management (PTM) and Insignia Financial (IFL).
The team at UBS combines insurers with other financials (ex-banks) and expects to see 'good news' from Computershare, Suncorp Group (SUN), Steadfast Group (SDF), nib Holdings (NHF), Challenger, Netwealth, and Pexa Group (PXA).
For negative surprises (most likely), UBS has singled out the ASX (ASX), Insurance Australia Group (IAG), AMP (AMP), Pinnacle Investment Managers, and Magellan Financial (MFG). Since the publication of that list, IAG has issued a profit warning and Pinnacle's market update equally received a good old fashioned share market shellacking.
Computershare is UBS's general top pick for the sector, followed by QBE Insurance (QBE), Netwealth, Hub24, and Steadfast Group. The bottom of the ranking is made up by Magellan (last), preceded by AMP and Pinnacle Investment.
When it comes to exposure to consumer spending, Macquarie suggests the local packaging sector comes with a relatively defensive profile, but companies are not 100% immune from a pending slow down.
Macquarie's sector preferences see Orora (ORA) placed first, followed by Amcor (AMC), then Pact Group Holdings (PGH).
Analysts at Evans & Partners are equally more positive on Orora, with a neutral position on Amcor.
Goldman Sachs prefers Corporate Travel Management (CTD) and Webjet (WEB) over Flight Centre (FLT) ahead of result releases.
Overall, the broker anticipates investors' focus is about to shift away from topline momentum for this sector to cash and profit generation, as well as "longer term strategic use of cash".
Sector analysts at Citi have chosen a different angle. They see indications that last year's strong recovery is stalling, but still, momentum for the likes of Webjet and Qantas should be strong enough. More volume-based business models, such as those of Corporate Travel and Flight Centre, may err on the softer side, suggests Citi.
Sector analysts at Goldman Sachs made a big call in January: they see the local telecom sector enjoying its most attractive outlook for revenue growth in many years
A return in population growth, plus international travel, combined with less intense competition should assist companies like Telstra (TLS) to offset pressures from inflation, predict the analysts. They remain equally positive on data centres.
Goldman Sachs' two sector favourites are Telstra and NextDC (NXT). The broker has a Sell rating for Spark New Zealand (SPK).
February 2023 will revolve around cost control and margins, predicts Goldman Sachs. Consumer sector preferences lay with Woolworths Group (WOW) and recent offshoot Endeavour Group (EDV), plus Breville Group (BRG).
The broker has Sell ratings for Wesfarmers (WES) and Coles Group (COL).
Generally speaking, analysts remain sceptical about the outlook for discretionary retailers later this year. Goldman Sachs is not an exception.
One sector that keeps polarising as forecasts for a tougher consumer environment later this year weigh on sentiment is the local real estate sector. Analysts at UBS anticipate investors' focus is shifting towards capital requirements (yes or no), the health of underlying tenants/subsectors and the outlook for transactions/asset values.
UBS's Buy rating are reserved for Stockland (SGP), Goodman Group (GMG), GPT (GPT) and Lendlease (LLC). The broker has Sell ratings for Vicinity Centres (VCX), Charter Hall Long WALE REIT (CLW), and BWP Trust (BWP).
Goldman Sachs' Predictions
Looking forward to the upcoming reporting season in general, analysts at Goldman Sachs are forecasting positive news flow (likely upside surprises) from QBE Insurance, Qantas Airways, Temple & Webster (TPW), Judo Capital Holdings (JDO), Endeavour Group, Corporate Travel Management, Qualitas (QAL), Data#3 (DTL), Telstra and Breville Group.
Candidates listed for a likely negative surprise are Sonic Healthcare, Coles, Bega Cheese (BGA), a2 Milk (A2M), Tabcorp Holdings (TAH), Dicker Data (DDR) and Altium (ALU).
Morgan Stanley's Key Picks
Morgan Stanley's Small Cap Key Picks for February:
In a positive manner: Dicker Data (DDR), Jumbo Interactive (JIN), Premier Investments (PMV)
While advocating investors be more cautious towards: ARB Corp (ARB), Bapcor Holdings (BAP), and Lovisa Holdings (LOV)
Australian banks do not generally report in February, with exception of CommBank (CBA) and Bendigo and Adelaide Bank (BEN). The latter is reportedly in merger talks with Bank of Queensland (BOQ) while the focus on CommBank mostly revolves around its hefty sector premium.
The sector in general seems positioned for strong operational momentum, for now. Again, plenty of sceptics around who wonder what momentum will look like when RBA rate hikes start impacting later this year.
Overall, February should still see a strong return of capital to investors through dividends and share buybacks though general anticipation is for the first signs of 'plateauing' to announce themselves. Resources companies will be paying out less than last year, and likely less again next year.
Banks are still in post-covid recovery mode and no dividend cuts are anticipated, not even with the anticipation of a tougher period ahead.
Those aforementioned Quant analysts at Citi are pretty confident about positive surprises from Brickworks (BKW), CommBank, Coles, Fletcher Building (FBU), Goodman Group, Imdex and ResMed. Again, the latter hasn't genuinely played out as expected.
Have been identified for a most likely negative surprise: 29Metals (29M), Corporate Travel Management, Flight Centre, and Monadelphous (MND).
FNArena's Corporate Results Monitor:
Starting tomorrow today FNArena's Corporate Results Monitor will be updated each week to include analysts responses to financial results.The service includes a calendar for the weeks ahead.
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