Better than expected
As a result of the uncertainty from further lockdowns in late 2021 and concerns around inflation in January 2022, general expectations were cautious going into reporting season. The market expected profits to fall sharply from those companies that benefited from CV-19 and a muted outlook from most companies due to an inability to pass through rising input costs. However, February 2022 revealed that 43% of companies reporting beat expectations and only 20% missed guidance and that for the ASX 200 in aggregate earnings per share are expected to rise by 15%! The most significant increases came from energy and financials due to sharp increases in the oil price and solid lending growth in an environment of low bad debts.
Supply Chain Issues/Inflation
After the market sell-off in January on concerns around global supply chains and inflation, in February, questions around cost control dominated the analyst calls with management. The miners all reported strong headline results courtesy of surging commodity prices but are experiencing higher costs. BHP discussed record diesel prices, high ammonia nitrate prices (explosives) and labour shortages in Western Australia impacting production. Similarly, Fortescue reported a 20% increase in their per-unit cost to mine a tonne of iron ore in the December quarter, though with this cost at US$15 per tonne, profit margins remain high.
Retailers Woolworths, Coles and Wesfarmers saw profit margins crimped by rising costs. Woolworths noted that the grocer had seen $150 million in direct COVID-19 costs from daily rapid antigen tests for warehouse and distribution centre staff, as well as increased absenteeism from around 18,000 staff being forced to isolate over the half. Given the moves in oil over the first two months, we expect cost pressures to continue through 2022 based on the cost increases in moving goods through global supply chains.
Conversely, Westpac had a very positive February after delivering $1.6 billion in first-quarter cash earnings; this was ahead of market expectations due to cutting costs and rationalising its operations reducing expenses by close to $1 billion. Woodside saw sharply expanding profit margins in February, benefiting from stable production costs (US$5.30 per barrel of oil) and rising revenues. A feature of offshore LNG plants is the eye-watering upfront construction costs in the billions and a low ongoing marginal cost of production requiring minimal inputs and labour.
Show me the money
The main theme of reporting season was the significant increase in dividends being paid to shareholders. February 2021 saw a record $36 billion in dividends being declared by Australian companies to be paid to investors over March and April. This was a record for the interim dividend period and only marginally below August 2021, which saw $40 billion being paid out. This corporate largess is due to a combination of record iron ore prices (BHP, Fortescue and Rio), lower-than-expected bad debts (Commonwealth Bank) as well as a dramatic recovery in energy prices (Woodside)
Commonwealth Bank’s result is always one of the most closely scrutinised, not only because it is Australia’s second-largest company (losing its mantle as the largest company after BHP collapsed its listing in London), but also due to the nature of its business. With 15 million individual customers and businesses, the health of CBA often mirrors the health of Australia, and the bank provides investors with a very detailed report into the financial health of their customers. We were pleased to see CBA lift its interim dividend from $1.50 to $1.75 per share and almost back to the $2 per share paid pre-CV-19.
In addition to higher dividends, buy-backs were a feature of this reporting season, with CBA, Sonic Healthcare, JB Hi-Fi, Sims Metal and Amcor announcing measures to reduce their share count and boost future earnings per share. Due to the range of off-market buy-backs in 2021 that reduced franking account balances, most of these will be conducted on-market as direct purchases. However, JB Hi-Fi will conduct theirs off-market, where their investors will receive a combination of a tax-efficient capital return and a fully franked dividend which will see excess franking credits transferred from the electrical retailer’s balance sheets into the hands of investors.
Best and Worst
Over the month, the best results were delivered by S32, Northern Star, Challenger, Woodside and Endeavour. Despite the uncertain macroeconomic background and rising cost pressures, these companies reported strong earnings growth ahead of expectations and an optimistic outlook for 2022.
Looking at the negative side of the ledger, we will ignore travel-related companies such as Qantas, Corporate Travel and Flight Centre as their financial results are impacted by government-mandated lockdowns and rising oil prices, rather than poor management decisions. Appen, Dominos Pizza, Mineral Resources, Xero and Reece reported results that were poorly received by the market. The common themes amongst this group are high price to equity (PE) companies that delivered profit results below expectations, combined with forward profit guidance not consistent with high growth companies. Additionally, some Australian tech companies were sold off along with tech companies in the USA, despite meeting guidance.
Overall, we were reasonably pleased with the results from this reporting season for the Atlas Concentrated Australian Equity Portfolio. In general, the companies that we own reported improving profits and indeed, for a number of companies in the portfolio, February 2022 saw record profits, dividends and new buy-backs.
As a long-term investor focused on delivering income to investors, we look closely at the dividends paid out by the companies that we own and whether they are growing. After every reporting season, Atlas looks to "weigh" the dividends that our investors will receive. Our view is that talk and guidance from management are often cheap, and that company CFOs can use accounting tricks to manipulate earnings, but actually paying out higher dividends is a far better indicator that a business is performing well. Additionally, global macro-economic events and market emotions can temporarily cause the share prices of companies performing well to fall. Using a weighted average across the portfolio, our investors' dividends will be +67% greater than for the previous period in 2021, and every company held was both profitable and paid a dividend. On this measure, we are pleased with the results of the February 2022 reporting season.