For much of 2023, aggregate earnings estimates have been steadily retreating for the S&P/ASX 300 index, largely due to a rebasing of commodity price forecasts. Although until early August, earnings per share (EPS) estimates for industrials had proven resilient in the face of rising interest rates (falling just 2.5% from their peak), the rate of decline has since accelerated as continued cost pressures and a more disinflationary backdrop have taken their toll.
Although the number of companies beating estimates in the latest reporting period exceeded misses by a ratio of 1.3 to 1, the more important forward-looking ratio was not as strong. On this metric, the ratio of companies that upgraded results versus guidance compared to those that downgraded results versus guidance was just 0.7.
In this Observations report, we look at some of the key trends to emerge from the latest reporting season and what this means for investment markets for the remainder of the year.
Overall, EPS for the next 12 months for the S&P/ASX 200 index is down 11.6% from its peak year-to-date. At the beginning of the reporting season, this figure was -8.3%.
Following the conclusion of company results for financial year 2023, analysts now forecast that EPS for this financial year will fall by 4-6%. Prior to the latest results, the decline in this financial year’s results was forecast to be approximately 2%. A significant proportion of this decline is being driven by the energy and materials sectors. With global oil prices at their highest levels since November, and refining margins surprising to the upside, energy remains a swing factor.
China stimulus, or lack of it, also remains a key driver, with iron ore prices proving remarkably resilient in the context of very weak China economic data. Analysts are basing BHP, Rio Tinto, and Fortescue forward earnings on iron ore prices closer to USD 100 per tonne versus the current USD 115 per tonne. To provide some perspective, based on forecasts provided by Barrenjoey, at spot versus consensus commodity prices, BHP would see a 16% EPS upgrade, while RIO would see a 20% upgrade to one-year forward earnings. Higher-for-longer commodity prices or a surprise China stimulus would likely result in aggregate EPS upgrades for the major miners.
Higher-for-longer commodity prices or a surprise China stimulus would likely result in aggregate EPS upgrades for the major miners.
Although the Commonwealth Bank of Australia (CBA) was the only major bank to report earnings this season, the other major banks provided Q3 trading updates. Although earnings are still being downgraded, it is interesting that the ‘rate’ of downgrades has slowed appreciably. In fact, CBA earnings for this financial year were lowered less than 1% and National Australia Bank (NAB) and Westpac have seen upgrades of approximately 1% or more. This inflection point is important for several reasons. Net interest margin (NIM) pressure appears to be stabilising, if not abating, as deposit and mortgage competition becomes more rational. Secondly, the announcement of buybacks by CBA (AUD 1 billion) and NAB (AUD 1.5billion) is a positive signal in terms of outlooks for bad and doubtful debts.
Since the rate-tightening cycle began last year, investors and bank management have been very cautious on the outlook for asset quality. This has seen banks continue to strengthen balance sheets, accumulating large loan loss provisioning and widening capital buffers to mitigate the impact of an onerous bad debt cycle. However, recent updates have shown that there is no sign of a material deterioration yet. Furthermore, banks are signalling that capital buffers are sufficient to navigate a higher interest rate environment and may, in fact, be superfluous to needs. Consequently, the S&P/ASX 300 Banks index has outperformed the market over the past 12 months—but more recently, that level of outperformance has widened. With protected balance sheets, a resilient housing market, and reasonable valuations, it’s possible that the banks will provide a level of support for the broader market, especially given institutional fund managers are largely underweight.
Technology and materials have seen the largest downgrades to dividend per share estimates, followed by healthcare and energy. On the flip side, estimates for utilities were revised up, with more modest increases for financials and consumer discretionary.
On average, the market revised down dividend per share (DPS) estimates by 3.3%. Technology and materials have seen the largest downgrades to estimates, followed by healthcare and energy. On the flip side, DPS estimates for utilities were revised up and there were also more modest increases for financials and consumer discretionary. Like EPS estimates, we have seen more downgrades (42%) than upgrades (19%). According to JPMorgan data, this is the lowest level of upgrades on record. Taken in conjunction with forward guidance, this suggests that boards are exercising some caution in relation to balance sheets and cashflow, and hence payout ratios.
During September and October approximately 160 companies will be reaching their dividend pay dates. This represents, in aggregate, approximately AUD 24 billion, with close to AUD 21 billion being paid in September.
Greater labour and interest expense, as well as capex over-runs, were a dominant theme for domestically exposed companies.
An enduring theme of the recent reporting season was persistent and, in some cases, escalating, cost pressures. Greater labour and interest expense, as well capex over-runs, were a dominant theme for domestically exposed companies. There was also a broadening of cost pressures, including energy, insurance, rent, transport, and technology (or reinvestment) spend.
According to UBS, stocks where labour costs (or shortages) are proving a headwind to profitability include Boral, Coles, G8 Education, JB Hi-Fi, Netwealth, Sims, Sonic Healthcare, Super Retail, Seven West Media, Telstra, and Woolworths.
For now, many companies are still trying to offset cost pressures by increasing their selling prices. Last financial year’s results showed that companies are continuing to have some success on this front, with profit margins resilient and aggregate EBITDA (earnings before interest, tax, depreciation, and amortisation) margins consistent with year-ago levels. The longevity of this will start to be drawn into question, with disinflationary pressures feeding through over the next six to 12 months. Despite headline resilience, there was growing divergence among sectors, with pressure in the communication services, materials, and consumer staples sectors. On the positive side, the consumer discretionary sector appears to be managing costs effectively.
As the bulk of homeowners transition from fixed to floating rate home loans, there is tremendous uncertainty as to how the Christmas trading period will evolve.
The results from financial year 2023 suggest that the Australian consumer is not as weak as initially feared. However, as the bulk of homeowners on low fixed-rate loans transition to higher floating rate home loans, there is tremendous uncertainty as to how the Christmas trading period will evolve. It’s possible that that weakness in the consumer has a long tail and could broaden out to other sectors in the economy. Buttressing this will be strong levels of forecast migration and a likely full employment backdrop. Harvey Norman provided a soft trading update, while the major banks suggested that credit card spend was slowing. More positively, JB Hi-Fi delivered a positive set of results, and the consumer discretionary sector has been the best performing sector in the S&P/ASX 200 index since the end of July, rising 5% against a market that has fallen 1.4%. Within this, Wesfarmers’ value and low-cost offering across Bunnings, Kmart and Officeworks suggest that the consumer is becoming increasingly price conscious.
Unlike in the US where many corporates have significantly termed out their debt maturity profile and at low fixed rates, Australian companies typically have shorter maturity profiles and a greater exposure to floating rates. Consequently, there was an expectation during the reporting season for Australian corporates to report higher interest costs, given how sharply interest rates have risen over the past year. As expected, most real estate investment trusts (REITs) flagged increases in debt costs, but what concerned investors was the breadth of companies reporting an increase in interest rate costs beyond the typically levered sectors like REITS. Ramsay Health Care, Aurizon, Carsales.com.au, Charter Hall Long WALE REIT, Endeavour Group, Ansell and Sims all surprised negatively at the interest expense line.
Growth stocks outperformed value, despite the valuation pressure on expensive long-duration stocks due to 10-year bond yields rising above 4%.
From a factor perspective, growth added more alpha than value during reporting season, outperforming by approximately 150 basis points, albeit both factors were negative. Interestingly, growth stocks outperformed, despite the valuation pressure on expensive long-duration stocks due to 10-year bond yields rising above 4%. With that said, there was considerable dispersion of performance among growth stocks. For example, Domain Holdings, WiseTech and Seek Limited delivered weaker-than-expected results, whilst companies such as Altium, Carsales.com.au, Goodman Group and Pro Medicus materially outperformed. The inference here is that valuations were considered ‘tolerable’ if there was clear demonstration of ongoing earnings momentum.
During August, market returns favoured industrials over resources across both the S&P/ASX 200 and Small Ordinaries indices. When looking at the quantitative factors for the month, quality, momentum, and growth produced positive relative returns.
Over August, the S&P/ASX Small Ordinaries index delivered a -1.3% total return versus the S&P/ASX 50, which fell 0.6%. Although Small Ordinaries EPS growth was forecast to deliver a robust 14.7%, the reporting season saw forward estimates revised lower by 2.3%. Dividend estimates were cut more aggressively for small caps, falling 3.7%.
With reporting season complete, investors will soon turn their focus to annual general meetings over the next several months for clues as to how persistent cost pressures are, and whether companies are still seeing resilient revenue trends. At a broad level, we favour a bottom-up, style-agnostic approach to investing. One of the more pervasive themes that has emerged over 2023 is that idiosyncratic opportunities are presenting themselves within the context of what has been a rangebound market. We favour companies where valuations are reasonable, with a suitable dividend and free cash flow yield buffer to the competitive returns now on offer in fixed income.
For a list of stocks with the largest price target changes this reporting season, click here
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