August 2019 Verdict: Strength From The Few
On the micro-level, a failed or splendid financial performance release can have a noticeable impact on a company's share price up to three months down the track.
On the macro-level, recent observations suggest beats and misses can set new trends for sectors and broad themes, or keep the momentum going for longer.
With the August reporting season revealing more weakness, and most performance disappointments, from laggards and cheaply priced companies, the obvious conclusion might be it remains way too early to predict the downfall of highly priced, rapidly growing performers.
Patient investors in lagging building materials companies, retail landlords, listed professional value investors and small cap financials might have to be patient for longer.
If I restrict my memory to the past two years, investors turned cautious and sceptical ahead of the February reporting season in 2018, but were subsequently blown away by results released by Appen, Altium, WiseTech Global, CSL, ResMed and most other highly popular, High PE growth stocks which then re-launched the momentum for Growth in the share market until the following August, when the scenario pretty much repeated itself.
We recall that CSL shares rallied no less than 15% after updating its financials that month, which only broadly met expectations at the time.
Then followed a nasty and volatile downturn. By February this year, the previously virtually untouchables, including ResMed, CSL, etc, started releasing financial reports that either missed expectations or proved merely OK. This then, of course, begged the question: has the time finally arrived for cheaper priced "value" stocks to have their moment under the sun?
It turns out, that swing in momentum hardly made it into August. Even miners and energy companies merely showed their weaknesses throughout last month, disappointing on multiple levels except when larger dividends and share buybacks had been announced, which in itself poses a few questions regarding operational performances against cost controls and boards inclined to offer compensation.
General weakness in commodity prices exacerbated the weakness in share prices. Right at the cut-off of reporting season, nickel popped up as the against-the-general-trend exception, alongside gold.
As things turned out, corporate Australia is in a vulnerable state with plenty of sectors battling multiple headwinds. Against this background, good old bricks and mortar retailers delivered the stand-out, positive surprise in August. Their performance was matched by the High Quality names of CSL, ResMed, REA Group, Altium, WiseTech Global, Goodman Group, Charter Hall, and numerous others.
But nothing can mask the cold hard impartial observation that August 2019 marks the weakest reporting season since August 2013, when FNArena started keeping detailed records and stats. We didn't know it at that time, but August 2013 was a pretty weak reporting season. August this year has, for the very first time since we keep records, generated more "misses" than "beats" in the corporate results releases.
If we combine the recent reports with the fact that both preceding reporting seasons in 2019 (February and March-July) only saw total "beats" equalling "misses" on each occasion, one can only conclude things are incredibly tough and challenging for large parts of the Australian economy. Judging by the latest update, the broad trend is not improving either.
We can all but wonder what exactly the impact could have been on the local share market if the general background was not made up of central banks loosening policies, including the RBA, and a global investment community thirsty for yield. A weakening Aussie dollar will be keeping hopes alive that more of the benefits will start showing up in the six months ahead.
August Report Card
Few will criticise or deny, some of the strongest performances in August were released by CSL ((CSL)), WiseTech Global ((WTC)), AP Eagers ((APE)), Infomedia ((IFM)), IPH ltd ((IPH)), James Hardie ((JHX)), Magellan Financial ((MFG)), Medibank Private ((MPL)), Pro Medicus ((PME)), and ResMed ((RMD)).
Special Note: none of these companies fall into the category of cheaply valued stocks.
Strong performing retailers include Accent Group ((AX1)), JB Hi-Fi ((JBH)), Baby Bunting ((BBN)), and Shaver Shop ((SSG)) while all companies in car leasing and salary packaging came out solidly too with Smartgroup ((SIQ)) and McMillan Shakespeare ((MMS)) taking sector honours.
Companies that proved the doubters wrong include Bapcor ((BAP)), Treasury Wine Estates ((TWE)) and Lendlease ((LLC)).
Companies that in particular disappointed include Boral ((BLD)), Brambles ((BXB)), Bellamy's ((BAL)), Blackmores ((BLK)), Cimic ((CIM)), Citadel Group ((CGL)), Cleanaway Waste Management ((CWY)), Costa Group ((CGC)), CYBG ((CYB)), G8 Education ((GEM)), Ingham's Group ((ING)), Insurance Australia Group ((IAG)), Orora ((ORA)), Pact Group ((PGH)), and Virtus Health ((VRT)).
But nothing compared to the Big Question Mark that is now attached to Pioneer Credit ((PNC)), Smiles Inclusive ((SIL)) and Speedcast International ((SDA)). Serious questions also persist for Corporate Travel Management ((CTD)), Collection House ((CLH)), and Virgin Australia ((VAH)), while patience must be running out for shareholders in value-investors on the wrong side of history, including Platinum Asset Management ((PTM)) and Perpetual ((PPT)).
Miners and Energy producers largely failed to impress, delivering rather mixed performances with positive stand-outs delivered by Santos ((STO)) and Origin Energy ((ORG)), as well as some of the coal producers, but the sector offered plenty of disappointment including from Iluka Resources ((ILU)) and BlueScope Steel ((BSL)).
Among High Growth, High PE names a2 Milk ((A2M)) surprised against the trend negatively, on the need for increased investment, and Domino's Pizza (DMP)) has ceased providing guidance, having now missed it three reporting seasons in a row. IDP Education ((IEL)) got punished severely, which also happened to Nearmap ((NEA)) shares. Jumbo Interactive ((JIN)) experienced similar, but that lasted but a brief moment.
Plenty of potential turnaround stories delivered yet more evidence any turning around might require a lot more time, and maybe a good chunk of luck too - see also last week's Weekly Insights. Financials in particular stood out with plenty of weak results.
Investors should be aware market speculation has it Westpac ((WBC)) is considering raising additional capital in order to prevent having to cut its dividend while recent regulatory tightening by APRA has singled out ANZ Bank ((ANZ)) as possibly most at risk from forthcoming regulatory tightening in New Zealand. This is why shares in Commbank ((CBA)) and National Australia Bank ((NAB)) have been the better performers in the sector recently.
See also "Capital Controls Another Knock To Banks" published on Tuesday:
(Most) Trends Are Negative In Australia
In terms of underlying trends, the momentum in earnings forecasts is negative, was negative prior to and during August and is expected to remain negative in the lead-up to the February reporting season next year. According to AMP's chief economist Shane Oliver earnings downgrades during August have dominated by more than two to one versus upgrades.
Earnings downgrades have been greatest among energy stocks, financials, telcos and industrials. Ultimately, the dial stopped at 1.5% growth in earnings per share for FY19, but without resources it was negative: -2%. Forecasts for FY20 have now fallen to an average of 6.3%, but it shouldn't surprise to see this halve, or worse, by this time next year.
Oliver also reports only 58% of companies have seen earnings rise from a year ago compared to 77% this time a year ago. In addition, only 49% of companies raised their dividends, well below the norm of 62%, while 28% of companies cut their dividends, the most in the last seven years.
FNArena counted 65 upgrades in stock-specific recommendations in relationship to released profit reports, while 71 downgrades were issued. The average consensus price target rose by 2.49% throughout the month. As stated earlier, never before did we witness a local reporting season wherein more companies missed expectations than managed to beat them. The final percentages stand at 24.4% (77 companies) "beats" versus 25.3% (80) "misses".
Historically, the near 2.5% increase in targets doesn't look too bad (but it hides the sharp bifurcation behind the average) while total misses are on the high side. The percentage in "beats" is the lowest recorded for any reporting season since 2013.
CommSec & UBS
Some additional insights are worth highlighting from analyses published by CommSec and UBS to wrap up the August reporting season. CommSec limits its research to constituents of the ASX200 of which 138 released full year numbers in August and 31 others published interim reports. UBS stays within the boundaries of those stocks that are actively covered by its own analysts.
A high number of 92% of companies reported statuary profits, on CommSec numbers, which is above the long term average of 88%, but only 52.2% of those companies managed to grow their profits. More companies -88.4% versus the average of 86%- elected to pay a dividend to shareholders.
CommSec reports the 52.2% is better than the February reporting season earlier in the year when only 48.6% managed to grow profits from a year earlier. February marked the second lowest percentage on this measure since 2010, only beaten to the downside by August 2011.
In aggregate, revenues lifted by 6% but expenses (costs) rose by 6.8%. And while dividends increased by 4.9%, CommSec numbers reveal aggregate cash generated fell by -0.1%. Also, dividends in total only grew because companies including Rio Tinto, ASX, Coles and Medibank Private paid out special dividends. Excluding these, aggregate dividend payments fell by -0.6%.
Of those companies paying out a dividend, 21.3% cut the dividend and 23.8% kept dividends unchanged. The 54.9% that chose to pay out a higher dividend represents the smallest proportion in around six years on CommSec data. All in all, these numbers suggest it has been a tough six months, if not twelve months for corporate Australia, which is also the view of CommSec.
Analysts at UBS are decisively more blunt about it, calling August "a reporting season to forget". The weakest in six years, on UBS's assessment, and the timeline only stops there because that's when the current team starting gathering stats and records. Incidentally, CommSec suggests it may well have been the weakest season on record for the past decade.
Maybe we should simply call it possibly the worst performance we all have witnessed in Australia post GFC?
FY19 achievements were generally weak, highlights UBS, but on top came generally soft forward guidance. The upgrade-to-downgrade ratio for August stopped at 0.6; the lowest in five years. A minority managed to trigger noticeable upgrades to forecasts. Most results were followed-up with reductions.
UBS still thinks FY20 forecasts remain too high, in particular for Financials, but the analysts also concede ultra-low interest rates do offer compensation.
UBS was mostly pleased by the fact that 36% of large cap companies beat expectations on dividends, while only 15% missed. Playing the Devil's Advocate here, is this not merely a sign these boards felt they had to put in an extra effort to compensate for disappointment elsewhere?
The trend in earnings revisions remains decisively negative and UBS highlights once again Resources remain the offset while Industrials ex-Financials are currently trending well below average. For Financials, current negative EPS revisions are the worst since the GFC on UBS's numbers.
Post revisions, market consensus now expects 6.3% market EPS growth in FY20, with strongest outlook for Resources (+9.2%), then Industrials ex-Financials (+8.4%), with Financials (+3.7%) the weakest.
UBS thinks the more realistic outcome will be for 3% EPS growth, supported by Resources, implying Industrials, but more so the banks and other Financials are likely to remain subjected to downward trending forecasts.
Share Market Valuation
The August reporting season is unlikely to stop the public debate about whether share prices are too richly priced, or not. On FNArena's observation, index weakness in August and in early September means only a minority of the circa 400 active ASX-listed stocks in our database are trading above consensus target.
While this includes regular and obvious offenders such as WiseTech Global, Cochlear and Altium, it also applies to portfolio staples such as Woolworths ((WOW)) and Wesfarmers ((WES)). In broad terms, most ASX-listed stocks that are on most investors' radar are trading below consensus target.
The obvious comment to make here is that none of these targets incorporate the prospect of an economic recession, here in Australia or elsewhere. Given ongoing risks globally, this is something investors should bear in mind. Ditto for prospective earnings growth potential and dividends.
If we look at where the Big Four banks are at, we notice CommBank shares are trading solidly above target, while National Australia Bank is above and Westpac close but below its target. ANZ Bank is the current laggard in the sector leaving a gap of a little less than -4%.
Assuming the Big Four can still be used to assess investor sentiment in general, I'd be inclined to suggest overall sentiment remains elevated, but not extremely so. Given risks have definitely risen for local banks, also see above, there is but a fair argument to be made share prices should be lower, not higher in the short term. Whether this also applies to the share market in a broad sense is likely to be determined by macro factors and uncertainties.
Craig James and Ryan Felsman, economists at CommSec, agree with my assessment that Australian shares may not be as bloated on valuations as it may seem at first sight, also considering central bankers in support and exceptionally low bond yields. CommSec expects the All Ordinaries to range between 6700-7000 by year-end, while the ASX200 is expected to range between 6600-6900.
UBS analysts note High PE Growth companies have been among the better performers in August, both on results and in share prices, which means the Top End of the Australian share market is now trading on an average Price-Earnings (PE) ratio of 25x, a new cycle high.
All-Weather Portfolio Performance
In line with all of the above, the FNArena/Vested Equities All-Weather Model Portfolio significantly outperformed the broader share market in August with several portfolio constituents posting sizable rallies upon releasing financial results. Only a small number genuinely disappointed.
Whereas the ASX200 Accumulation Index dived deep in the red, and recovered somewhat during the final days of the month, to post a -2.36% loss following a positive performance of 2.94% in July, the All-Weather Portfolio posted gains of 2.95% in July and 0.47% in August.
The combined performance for the All-Weather Portfolio over the first two months of the new financial year is thus 3.43% compared with 0.52% for the ASX200 Accumulation Index.
Attached is FNArena's final assessment of the August 2019 Australian corporate results season.
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