The somewhat lackadaisical market sentiment leading into the February reporting season stands in sharp contrast with the hefty profit upgrades by analysts over the past four months. Depending on whose numbers we take as guidance, average profit growth (EPS) for the Australian share market this financial year increased over that brief period from a mere 6-7% to between 13-19%. If these numbers still stand by the end of August, the Australian share market might well be about to experience its strongest year for profit growth post-GFC. Note that a big chunk of this growth won't show up until the August reporting season, but even so the underlying trend is firmly upwards and by then the average might well be a lot higher. The downside to all of this is that virtually all of the increases in forecasts have occurred in the resources sector and in the resources sector only.
The banks, for example, have not enjoyed any noteworthy uplift in forecasts. Their risk profile has improved somewhat, predominantly because Basel regulations might be pushed further out or abandoned altogether. According to some analysts, bank management teams might anticipate better margins for the second half, which would certainly please investors. It will also further fuel the emphasis on the second half, just like it will be the case for iSentia ((ISD)), for Vocus Communications ((VOC)) and for a large group of other companies that will be extra scrutinised this month for any indications about what can reasonably be achieved between now and late June?
As per usual, the largest gains and losses will be for those companies whose financial report genuinely surprises. Which means most among us are unable to predict these events beforehand (it cannot be a "surprise" otherwise). Feedback from the local funds management industry is that many portfolios have been de-risked in recent weeks. Everybody wants to avoid holding the next Aconex when yet another negative surprise hits the ASX website.
This explains the rather erratic price action for many medium sized, high PE industrial stocks leading into February.
Video: Beats & Misses - how surprises impact share prices...
General Themes This February
It is likely the dominant question asked by investors this month will be: what are mining companies going to do with all that cash that is flowing in? It was only twelve months ago market speculation was focused on who might be next to go out of business? Today expectations are rife about which company might be handing back cash to shareholders?
Rio Tinto is widely speculated to potentially announce a $3bn share buy back this month, even though a conservative board might wait until August. Maybe a firm hint might do the trick, for now?
BHP Billiton is still carrying too much debt, but others might soon be in a similar position as is the cash luxury at Rio Tinto. Think South32, Whitehaven Coal ((WHC)), and others.
Another big change is a reversal of momentum among supermarkets. Analysts are warming towards the idea that Woolworths is taking back market momentum from Coles. Recent price action for Woolworths and Wesfarmers ((WES)) shares is reflecting this.
General momentum for retailers is, once again, murky at best. Expectations are that electronics sales continue to do well with potential for JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)) to come out better than market expectation, but otherwise retail remains a sector filled with minefields, as has been the case for quite some time now. Profit warnings by the likes of Oroton Group ((ORL)) and Shaver Shop ((SSG)), as well as unlisted apparel shops going into administration do not set a positive tone beforehand.
Former yield investor darlings Transurban ((TCL)) and Sydney Airport ((SYD)) are expected to release strong earnings reports. Too bad general sentiment remains against the sector on expectation of prolonged rallies in government bond yields later in the year.
Stocks mentioned as likely candidates to release a negative surprise include Automotive Holdings ((AHG)), CSG Ltd ((CSV)) and Flight Centre ((FLT)).
The Brokers' Picks
Every reporting season triggers confessions and predictions from stockbroking analysts about who is their sector favourite and who's seen as most likely to disappoint. This exercise always opens up some spectacular misses. Brambles pre-profit warning was Deutsche Bank's sector favourite while stockbroker Morgans not so long ago had Bellamy's ((BAL)) among its Conviction Buy ideas.
Yes, there was also a lot of conviction at Morgan Stanley behind the outlook for Aconex, but that has been extensively reported upon elsewhere.
In many unreported cases stockbroking & analysts do get it right, and below are some of the snippets published recently.
Credit Suisse finds JB &H i-Fi & is likely to outperform market expectations, as should Myer ((MYR)), while Flight Centre might not disappoint just yet given the heavy skew to H2 in this financial year's guidance.
Over at Morgan Stanley, strategists have updated their "Australia Sustainable Leaders Conviction List"' by removing ResMed post earnings surprise and subsequent share price response. No additions were made so the selection consists of: ASX Ltd ((ASX)), Westfield ((WFD)), AMP Ltd ((AMP)), Dexus Property ((DXS)), Insurance Australia Group ((IAG)), Investa Office Fund ((IOF)), Orora ((ORA)), Sonic Healthcare ((SHL)), Spark New Zealand ((SPK)), Sims Metal ((SGM)), Mirvac ((MGR)) and Henderson Group ((HGG)).
Deutsche Bank analysts are not too keen on Brexit exposures and prefer to remain cautious towards companies relying on consumer spending in Australia. They note for offshore-exposed industrials the tailwind of a weakening AUD is abating.
Deutsche Bank suspects a potential upside surprise from Amcor, Fletcher Building ((FBU)), Harvey Norman, JB Hi-Fi, QBE Insurance ((QBE)), Rio Tinto, Star Entertainment ((SGR)). Potential downside surprise might stem from REA Group ((REA)) and/or from WorleyParsons ((WOR)).
UBS is not expecting any fireworks from the general insurers but suggests companies could surprise with a better than anticipated outlook/guidance. A similar scenario is thought possible for Computershare ((CPU)). For both IOOF ((IFL)) and Perpetual ((PPT)) the risks are seen as to the downside.
UBS strategists much prefer international growth stories, preferably with & US exposure, albeit selected consumer discretionary names are expected to perform strongly this month. They like Harvey Norman, Super Retail ((SUL)) and Costa Group ((CGC)).
The strategists added Boral ((BLD)), Computershare, Origin Energy ((ORG)) and Woolworths to their Model Portfolio, having removed Brambles, Caltex Australia ((CTX)), Healthscope ((HSP)) and Incitec Pivot ((IPL)).
The Top Ten of most Overweight positions held by the UBS Model Portfolio are: Aristocrat Leisure ((ALL)), BHP Billiton, BlueScope Steel ((BSL)), Boral, CSL, Harvey Norman, Lend Lease ((LLC)), Orora, ResMed and Stockland ((SGP)).
Stockbroker Morgans has now removed GBST from its High Conviction List. Still on the list are: Westpac ((WBC)), Orora, & South32, ResMed and ALS Ltd ((ALQ)) from the Top100 and from outside the Top100 Evolution Mining ((EVN)), Corporate Travel ((CTD)), Speedcast ((SDA)), Kina Securities ((KSL)), Catapult Group ((CAT)) and Impedimed ((IPD)).
Shaw & Partners advocates a cautious ("neutral to underweight") balanced portfolio weighting towards the Australian share market. The stockbroker recently communicated to its clientele "The spectre of rising long term interest rates, potentially harmful trade policies emanating from Washington, event risk around reporting season as well as the cocktail of geopolitical risk from Brexit to the EU makes us nervous".
The recent model portfolio update saw the removal of both Telstra ((TLS)) and Westpac and the inclusion of QBE Insurance and Northern Star ((NST)).
Market starting on the back foot
The Australian share market is starting the new calendar year on the back foot. The Trump-inspired rally has largely ran out of puff as the world's focus shifted from a potential new Reaganesque policy regime to the more darker characteristics of the populist, self-indulgent, non-conformist, erratic personality that is now the Leader of the (Free) World. (Ahem).
Australian bank shares trading well above stockbrokers' price targets (see Stock Analysis) without a commensurate improvement in analysts' forecasts hasn't helped either, & nor does the fact that Chinese authorities might be reining in excessive liquidity in their domestic economy.
Further weighing upon sentiment is most early corporate reports haven't been that flash -think GUD Holdings, James Hardie, & Virtus Health - while a number of others surprised with an unexpected profit warning. Brambles ((BXB)) might not be everybody's favourite & in today's share market, but it still is a Top20 member, and supposedly a more defensive and reliable option with low risk of a sudden negative shock announcement.
Combine Brambles with Aconex ((ACX)) and GBST ((GBT)) and we already have what might well be the early beginnings of potentially a negative narrative for the whole of February: are political uncertainty and risks in countries such as the UK and USA weighing upon corporate spending intentions?
Add worse than expected economic data (see the latest update on retail spending in Australia) and it probably should not surprise price action coming out of January and leading into the second week of February has been rather lethargic. The gusto and confidence from late 2016 have left the stage, or so it seems.
Positive surprises from CSL ((CSL)) and ResMed ((RMD)) have not been sufficient to offset the negatives.
Here and there strategists have started to mutter: better to reduce exposure to equities. Thus far, quantitative analysts at Credit Suisse have warned loudest. They see "heightened risk of an impending protracted market correction".
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