Reporting Season Playbook: Morgans' best stock ideas

An annual corporate earnings growth rate of just under 10% would normally pique investor interest – especially when you also throw in a below-average market price-to-earnings ratio of 13.5 times. But these are not normal times.

The tug-of-war between what the market expects to happen is at odds with what is currently occurring. We don’t disagree that higher interest rates portend lower economic growth but is  the market right to be worried about a collapse in earnings expectations? We don’t think so, but August won’t hold all the answers.

FY23 – from COVID recovery to a possible recession

While there are many reasons for investors to keep to the sidelines, and we agree the risk of negative surprise remains high, there are also reasons for
forecasts to turn out better than feared:

• lack of company guidance has seen many analysts err on the side of caution;
• less divergence amongst analyst forecasts implies higher forecast confidence; and
• fewer negative trading updates in May-July indicate a more stable operating environment.

FY23 EPS revisions from the past two reporting season

Profit margins in focus – demand side to be given more scrutiny

Until now, the demand side of the margin equation has received little scrutiny given the resilience of Australian consumption. But we’re seeing signs from the US reporting season that consumers are tightening their belts. Australia’s economy enjoys strong relative benefits to the US – including high commodity prices, and lower inflation. But demand, which is affecting volumes, operating leverage, and margins, will come into keen focus in August.

All-weather companies to combat inflation

Companies have several tools at their disposal to combat inflation. These include cost out, product premiumisation/mix, productivity gains, and cost pass-through. And there are several all-weather companies we think are capable of resisting cost inflation, including Woolworths (ASX: WOW), Coles (ASX: COL), and CSL Limited (ASX: CSL).

Operating margins for ASX Industrials made a clear peak in mid-2021 with investors questioning how far they will contract due to persistent supply-chain disruption, labour constraints/absenteeism, and input cost inflation.

The abolition of COVID restrictions/isolation rules was hoped to alleviate lower labour availability; however, many companies are now reporting absenteeism above pandemic levels, not helped by a severe flu season. We infer there is now
under-reporting of COVID cases linked to an element of ‘pandemic fatigue’ and see further COVID disruption as a clear risk. 

Overall, companies have several tools at their disposal to combat inflation. These include cost out (large cap franchises, banks, telcos), product premiumisation/mix (higher-end retail, REA), productivity gains (materials, CBA, MPL, HLS), and cost pass-through (LOV, BXB, AMC, RWC).

Morgans' key tactical calls for August

CSL Limited (ASX: CSL)

Morgans analyst Dr Derek Jellinek maintains a solid outlook for the biotech firm, with plasma colletions expected to continue improving via numerous initiatives. He tips EPS growth of 17% for FY2023 and a total shareholder return of 15% over the next 12 months.

Amcor (ASX: AMC)

Analyst Alexander Lu, CFA, believes the global packaging company has the potential to beat expectations when it reports FY22 results next month. Management has a good track record of meeting or exceeding expectations, and the tightening of FY22 EPS guidance at the top end of the range in May suggests to us the actual run rate could be higher due to management conservatism.

Orora (ASX: ORA)

The competing packaging firm’s half-year 2022 result was well ahead of expectations, with North America the key standout, says Lu. Ongoing momentum in North America could see the company deliver another strong result for the full year.

Potential misses ahead

At the other end of the ledger, some of the companies our analysts believe are likely to miss their guidance include:

APA Group (ASX: APA)

The natural gas transmission firm’s share price strength is over-emphasising the revenue benefit of higher CPI, says analyst Nathan Lead. At the same time, he says it doesn’t adequately account for the likely cost impact on both corporate costs and sustaining/IT CAPEX.

Ramsay Health Care (ASX: RHC)

The private healthcare provider’s third-quarter trading highlighted ongoing challenging conditions and volatility across all markets, says analyst Jellinek.

Ansell (ASX: ANN)

Margin pressure is likely to weigh on the results delivered by the maker of protective gloves for industrial and medical use, says Jellinek. This will be driven by softer Exam/SU demand/price coupled with high-cost inventories and logistics disruptions.

Looking through commodity volatility

We expect near-record levels of dividends to be announced but industry issues are likely to dominate including labour shortages, cost and production guidance, and deferred growth capital. We take a patient, conservative view, noting compelling, unchanged medium-term commodities fundamentals driven by chronic supply-side constraints. This scenario suits established low-cost producers over-leveraged producers or explorers/developers.