With August results season around the corner, investors will finally get a clear picture of COVID-19’s impact on corporate Australia. We know it’s going to be bad, but how much is already in the price? When Jun Bei Liu of Tribeca Investment Partners considers that question, she’s upbeat about the month ahead.

“… it’s important to work out which analysts have been too conservative on what sectors and possibly, you have quite a lot of upside for those companies.”

For Blake Henricks from Firetrail Investments, the big things to watch are how companies protect balance sheets and whether the market buys management narratives around structural changes in response to the pandemic.

They expand on their views in this interview, answer whether they’re bullish or bearish on banks, resources, healthcare, technology and energy stocks, and call out where the re-rating opportunities are.

Notes: Watch, read or listen to the discussion below. This episode was filmed on 15 July 2020.

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Edited Transcript

James Marlay: Welcome to Buy Hold Sell, brought to you by Livewire Markets. My name's James Marlay and I'm joined by Blake Henricks from Firetrail and Jun Bei Liu from Tribeca. We're getting ready for reporting season and it's going to be an odd one. It's the first time a lot of companies are going to go in, not really knowing what their earnings are going to be, and so we're going to chat with our guests, find out what they're doing to prepare and what they think about some of the biggest sectors on the Australian market.

A reason to be upbeat

James Marlay: Jun Bei, I'll start with you. First question, are you doing anything different for reporting season this year? How are you preparing for it?

Jun Bei Liu: Honestly, I think every reporting season, you're meant to do the same thing, that you're meant to understand the business and understand where earnings might come through and where the expectations are. Share price movements essentially are about surprises:  surprise on the upside, the share price goes higher, and surprise on the downside, the share price goes lower. That's something that you always have to do. Now, this reporting season will be very interesting because we are actually thinking that, heading into it, it's looking actually reasonably positive.

This is the thing that we're thinking because we have seen a significant amount of earnings downgrades in the last couple of months because we don't know what the earnings will look like, so analysts have gotten very, very conservative. So, heading into reporting season, it's actually important to work out which analysts have been too conservative on what sectors and possibly you have quite a lot of upside, for some of those companies.

Brace for dividends, cost-cutting strategies

James Marlay: Blake, whilst the earnings and the downgrades expectations have been perhaps a bit dour, the market's been having a bit of a raging old party, are you in the same boat as Jun Bei? Have you been doing anything different going into earning season?

Blake Henricks: I think there are two things to think about this earning season. JB's right on the EPS. Let's talk about DPS for a second. Typically, the ASX 200 pays out about 70% of earnings as dividends, current expectations for about 60%. We actually think it'll be lower than that because if you're sitting on a board, you're not going to pay out too much money. You're going to protect that balance sheet. The second thing we're going to see is a lot more on cost-cutting. We've seen many companies say this is an opportunity for a structural rethink; less office space, less people, and that's one thing you can control if you're a company, so lower dividends and more cost-out.

James Marlay: Are you expecting management teams to come to the table with more of a plan around what they are going to do, given we've been in this environment for three or four months? Have they had time to put together a more concrete plan?

Blake Henricks: I think what we'll get out of it is, the companies who've held their guidance will probably, potentially give guidance again, but that's only for the most defensive, because even some things that are typically defensive, toll roads, where you give DPS forecasts, you're probably not going to give those. So I think, when you're thinking about what management are going to do, they're going to give six-week trading, say we're ready for a range of scenarios, and the market will say, "Gee, I wanted to know more about what's going to happen in the future."

James Marlay: Right, so two things we got there. Jun Bei's looking for those, where the earnings expectations might be a bit downbeat. Blake's expecting dividends to get cut. 

Banks: bullish or bearish?

James Marlay: Let's get into a couple of sectors. Jun Bei, start with you. Bullish or bearish on banks?

Jun Bei Liu: Can I stay neutral?

James Marlay: I don't see that in the run sheet. No fence-sitting!

Jun Bei Liu: Okay, no fence-sitting, then I'll be just under the bullish tone because I think the outlook is not going to be great. The dividend will be cut by the banks and potentially be pushed out for another six months before we see any cashflow come through. And because they are such a bellwether of our economy and we're in a recession, earnings are not going to look great, but because they're on cheap valuations and because of all the stimulus that the government has pledged, it looks like it's working quite well for some parts of the economy. We do think valuation is cheap enough. And when things resume to normal, we do think it looks reasonably decent. But, right now, it's probably slightly above neutral for me.

James Marlay: Okay. Blake, banks, are you bullish, bearish, closer to the neutral?

Blake Henricks: I'll give you bearish, James, bearish operating trends. There's still competition, got to deal with the bad debts, but they are priced much better for the reality than they have been in the last four or five years. But I think the biggest question to ask is, everyone's talking about bad debts, are Australians going to be renovating their homes at a rate of knots while defaulting on their mortgages? Because something's got to give.

Commodities: bullish or bearish?

James Marlay: Well, one part of the market that's actually been relatively immune to the goings-on of the coronavirus is the commodity sector, a big part of the Australian market. Iron ore miners have been raging on. Gold's been a bright spot. Bullish or bearish on the outlook for the miners?

Blake Henricks: Bullish - very bullish on the miners. Yeah, you've got really super strong balance sheets. You've got supply, which is really being withdrawn, almost across the market. In Brazil, for iron ore, it's down. If you look at copper, it's down, because of COVID, and then in other sectors, the price is just too low, so supply is being taken out in areas, such as oil, they're in a great, great position.

James Marlay: Blake's bullish on the resource sector, who would have thought that the banks were cutting dividends and the miners are going to be boosting them? Are you bullish or bearish on the sector?

Jun Bei Liu: Certainly bullish into this reporting season. The dividend will look enormous, from especially some of the larger names. Cashflow looks fantastic and the dividend payout is fantastic, so I think that why we're very bullish on that front. Now, there are a few things that when you ask most of the managers that you talk to, most of the people are probably bullish, so just to be a little bit mindful that we have with some of the tail risks now starting to tick up.

Things like trade conflict, the geopolitical uncertainty, and all of that now, will create some of the risk on the horizon for that resources space, because we need global growth to really tick up, and in that fragile juncture at this point, if you have started having trade tensions and geopolitical sensitivities, it will certainly weigh on the sector. So it's just something to watch, but very bullish heading into the reporting season.

Healthcare: bullish or bearish?

James Marlay: The only thing that's been more bullish than resources has been healthcare. It's been a real sweet spot in the past little while. Has it got ahead of itself?

Jun Bei Liu: I think healthcare, there's a reason it's a bullish sector, because it has delivered that structural growth for many, many, many years, and that growth is underpinned, not by global growth. It's actually underpinned by demand for the unique product. So, each company has a unique exposure to something special about them, customers coming to them buy those products and that's the only place to get them.

However, I think the healthcare sector is at a very interesting crossroads. Some of them will do very well and others may lag behind a little. So the likes of CSL have delivered incredible growth over the years, but right now, because it has done well, in terms of its share price relative to others, it will be used as a funding source and its earnings might be facing a little bit of downgrade at this result.

But we're bullish on the likes of ResMed or Ramsay Healthcare, for example. We think both of them would deliver good growth, and in the case of Ramsay, it's going to benefit from the reopening thematic that is going to take place over the next six months, and the backlog for private hospitals is enormous. So overall in healthcare, you've got to be selective with what stock it is, and some of them you can do really well and these are V-shape recovery companies that you can see in this market.

James Marlay: Okay. Blake, have you go a V, a W or something else for the healthcare sector? Bullish or bearish?

Blake Henricks: Jun Bei's got it covered. I'm bearish overall. You do have to be selective. There's a couple of gems in there, but people have just crowded into it because of the defensiveness of the earnings and now there's a lot in the price.

Technology: bullish or bearish?

James Marlay: Technology, another sector that's been raging along. Bullish or bearish?

Blake Henricks: I'm bearish, technology. Still some gems in there, but I'd say, overall, with the types of discussions we're seeing out there in the market, there's just nothing factored in there for competition. There's nothing in the price for regulation. There's not much in there for the potential for higher rates or a stabilising economy. So, I think overall, I'm bearish versus current expectations.

James Marlay: Let's finish with you on technology Jun Bei. Bullish or bearish?

Jun Bei Liu: How long do I get? I like technology as a sector, but again, it's a stock by stock story. I really think the sector, the companies that are being impacted by COVID, and yet share prices are now probably at all-time highs. Some of those businesses will probably come under a bit of pressure at the reporting season, as people now start looking at the profit line and COVID has impacted some of those businesses, for example like Altium, WiseTech and the others. 

But there is another part of the technology sector that is seen as the beneficiary of it, and they have actually gone from strength to strength, and I do think these other companies certainly will become some of the brighter lights over the next 12, 18 months, because these businesses have now this structural uplift, in terms of growth outlook, and their end market is, or target market is essentially enormous.

One of the things with the equity market we're not very good at is estimating earnings for those companies, because, especially if you're innovative, how do you know what the growth might look? Is it 200, 300%? And these other businesses, if you get your earnings right, get your outlooks right and market right, you can make an enormous amount of return. Of course, it will be volatile, but these are the names where you do need to do more work and the position in them.

Potholes to avoid

James Marlay: Okay, can you help people stay away from a few potholes? Is there a sector or a part of the market that you think is a candidate to disappoint?

Jun Bei Liu: I am continuing to avoid the travel sector. Look, this doesn't include the airport. I like Sydney Airport, even though it is kind of travel, because Sydney Airport is a unique infrastructure asset. Its share price is not going to stay here for long, and at some point, it will be either bought out or a strategic buyer will come in, just because it's a very, very unique asset. 

But in terms of other travel-related sectors, it could be travel agents and others, I think these companies will go through prolonged pain. It will probably be a sort of prolonged U-shape or L-shaped type of recovery, and then their earnings structurally could potentially be much, much lower, over the long term, just because corporates work out you can save money and time by doing things over Zoom and the like, and we're all set up now. We all went to JB Hi-Fi, bought all the computers, so we're done.

James Marlay: It's structurally challenged now.

Jun Bei Liu: That's right. So I think there might be a bit of issue for all of those. There's just too much uncertainty for that sector for me to be interested in it.

A re-rating opportunity

Blake Henricks: I'll give you one to have a look at, if that's okay? I see a big rerating opportunity in oil. Everyone's so focused on demand and demand was very, very tough, but we are seeing it come back slowly. We're seeing a preference for driving, which is good for transport fuel demand, but I think when you look at what's it in the equity prices now, people have taken out the growth projects, but the fundamental part about the oil market is that it's a depleted industry and you need new projects to go forward. At $42 a barrel, there's still a lot of pain out there. 

So two things will happen. Once the market balances, the price will rise and the equity analysts in the market will start to re-price some of these growth projects again. So that's one where it's really on the nose, but at $42, it's still not sustainable and we see an upside to some of the oil stocks.

James Marlay: Well, folks, it's going to be an interesting reporting season. One thing you can be guaranteed is that it's going to be at one end or the other. It seems like people have got an opinion, bullish or bearish, on just about every sector.

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