Strong energy results, but who’s suffering inflation & labour pains?

Woodside outperformed the market last week, with standout cashflows, and earnings and the dividend ahead of expectations. For other companies, however, inflationary pressures and labour shortages are finding their way into prices and bringing a potential headwind for future profitability. But how much of this is a transitory impact of COVID? M&A, meanwhile, continues at pace, with Crown agreeing to a takeover offer this week, and private equity and pension funds continuing to compete for hard, long duration assets.

Edited transcript

The big energy companies all reported results last week including BHP’s energy division. Were there any surprises?

Woodside was the standout last week on energy companies. Cash flow was very strong and the profit and dividend beat market expectations and thus the stock outperformed on the day, despite a poor overnight oil price. Woodside (ASX:WPL) gave guidance around their exposure to gas hub prices that has increased to around 20-25% of LNG production going forward. Given the current and likely future of global gas markets, this surprised the market and will likely lead to upgrades given that exposure. The BHP (ASX:BHP) energy division merger with Woodside has a vote scheduled for the 19th of May, and when combined it will be a very strong, cash generative company with little debt and 90% of earnings will be coming from OECD countries. Overall it will be a very attractive energy company.

M&A was in sharp focus last week. You’ve previously discussed M&A a key thematic that you expect to see going forward. Do you still hold that view?

Given we have a combination of low interest rates, plenty of cash sitting on the sidelines and low top line growth, these factors will continue to be a big driver for M&A, both within Australia and globally. Despite interest rates moving higher they are still at very low rates historically, thus the cost of debt still remains lower than the cost of equity, making debt funding deals very attractive. We’re seeing both private equity and pension funds competing to buy hard, long duration assets, such as infrastructure or infrastructure-like assets such as casinos. Within Australia we’ve seen companies such as Sydney Airport (ASX:SYD), Spark Infrastructure (ASX:SKI), AusNet (ASX:AST) leave the bourse and Crown (ASX:CWN) is about to be acquired. This will continue globally, with perhaps renewable infrastructure assets being the next tasty asset on the menu.

inflationary pressures and labour shortages have been a key feature of many company updates. Is the inflation genie out of the bottle or do you think this is still a transitory COVID effect?

Cost inflation and labour shortages continue to be called out in reporting season by many companies. Wesfarmers (ASX:WES) talked about increasing cost of goods sold and JB Hi-Fi (ASX:JBH) now is expecting prices to rise. Freight and many input costs are still high which is partly being driven by COVID issues, and some of the stresses we are seeing in logistics are finding their way into prices. Orora (ASX:ORA) increased prices 13 times in their North American packaging solutions business, so there is no question that inflation is being seen across many companies and sectors, some of it is transitory but a lot of this will be baked in.

Lastly, as we come towards the end of February’s reporting period, what will you and the team be focusing on in the week ahead?

Week four this year looks even busier than week three, which is unusual. Both Coles (ASX:COL) and Woolworths (ASX:WOW) are reporting, and they have benefited from COVID and the lockdowns, albeit more recently increased costs due to COVID have hurt the bottom line despite the very strong top-line growth we’ve seen. Generally, both benefit from food inflation due to increased pricing, so it will be interesting to see if they call that out going forward. On a similar theme, Scentre Group (ASX:SCG) and Stockland (ASX:SGP) in their retail businesses will be interesting to see their expectations of the market moving forward out of lockdowns and COVID restrictions. 

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