Beating expectations

The Markets

This week: ASX v Wall Street

FYTD: ASX v Wall Street

We are almost half-way into Profit Reporting Season and so far, results across the market have been above analysts’ expectations.

And that is unusual.

Why? Well, analysts’ forecasts are notoriously optimistic.

Since 2001, analysts have downgraded their profit expectations by 0.7% on average following the reporting results (Source: MST Marquee)

Analysts’ expectations have been revised upwards by 1.3% for FY-22 profits thus far (to the 15th of February). However, this headline number was underpinned by strong results from financials, including the big the banks (namely CBA and NAB).

All in all, we continue to see the market focus on costs: with raw material and shipping costs continuing to be a point of discussion and higher labour costs creeping in.

And of course, while profits are important, they continue to be viewed within the context of a backdrop of rising inflation, interest rates – which in themselves pose the question: what should investors pay for these profits?

Upgrades to ASX 200 profit expectations are once again strong

Above: Upgrades/downgrades to next June ASX200 earnings per share during a reporting season month
*Source: MST Marquee*

We continue our coverage of your companies and their results in the first half:

Australian Equities sub-portfolio

Company description: Emeco is a mining fleet rental company with in-house maintenance capability. It has a strategy of purchasing mid-life assets and utilizing its maintenance capability to deliver stronger returns on investment. Recently it has acquired an underground mining services company as it looks to expand its operations.

1H-22 Result:

Emeco’s result was in line with our expectations, with operating earnings within the company’s guidance range and recently issued update.
Its transformation over the past few years is clearly evident:
From a highly leveraged rental business to a business which is now able to pay dividends and buy its shares back when they are cheap.
From a business with rental assets predominantly located in Eastern Australia servicing the coal industry to a mining services and rental business with much better geographical and commodity diversification (more skewed towards iron ore and gold in the West).
The rental business performed well considering challenges in the half (weather related disruptions in the East, labour shortages in the West).
The company’s Pit N Portal underground mining business is progressing well, however many projects are at an early stage and thus margins are below the company’s target levels. This should improve in the second half and into next year.
There were some cash costs in relation to debt retirement that surprised the market – but these are one off in nature.

Read through for FY-22 and beyond:

With the ramp up of Pit N Portal in the second half and easing of some of the challenges in the first half (such as labour constraints) the company is on track to meet its profit guidance for the year.
We see additional upside as operating utilisation of its fleet improves in the West (currently 60%), with the company highlighting that a move to double shifts has been hampered by labour constraints.
The company is currently trading on a free-cash flow yield of approximately 10%, that is, at the current level of earnings it can return 10% of its current share price every year to shareholders after all expenses and sustaining investment. We like companies that generate high levels of free cash flow (especially when they are cheap!) and took the opportunity to top up clients’ holding this week.

Company description: Newcrest is the largest gold producer listed on the ASX – with multiple producing mines and a strong pipeline of developments.

1H-22 Result:

Newcrest’s result was largely pre-announced given it reports its activity quarterly.
It’s performance in the second quarter (pre-announced) disappointed due to lower production levels than the market anticipated.
This was a result of reduced production from its two major mines (Cadia and Lihir). The mines were impacted by weather (Lihir) and a flow ramp up of processing facilities post the replacement of a major piece of equipment (Cadia).
It has been a busy half for the company, with the acquisition of Pretium Resources, which will add another Tier 1 mine and increase production by 15%.

Read through for FY-22:

Our focus remains on the role Newcrest plays in clients’ overall portfolios. The position provides exposure to the price of gold (the predominant driver of its share price) through quality low-cost, long-life assets.
This exposure provides diversification and a form of insurance during times of volatility and adverse market movements – something that is evident today as its price has risen with news of US-Russia tension escalating overnight.

Company description: Origin Energy is an integrated energy provider that is involved in power generation, energy retailing (electricity and gas) and the production/export of natural gas.

1H-22 Result:

There are two main moving parts within Origin: its Energy Markets (gas and electricity retailing) and Integrated Gas (upstream gas and Asia Pacific LNG joint venture).
Integrated Gas has been well supported by the strong oil price – with a majority of Origin’s contracts linked to the price of oil (Brent). This part of the business delivered strong cash flow over the half (~$555m). However, the company had hedged the price of oil at lower prices (to protect its balance sheet) and therefore some of this upside was capped.
Energy markets were softer than expected, with higher electricity prices yet to flow through tariffs and higher generation costs dragging down margins. Margins were also squeezed in gas retailing as procurement costs rose.

Read through for FY-22 and beyond:

The most material news item was the company’s announcement that it intends to shut its coal fired Eraring Power station by 2025. Our understanding is that this was by no means an ‘abrupt’ decision: Origin has engaged with the NSW government and AEMO for some time.
Lower wholesale electricity prices, particularly during the day (when there is an abundance of solar power) as well as rising coal prices have made it challenging to earn a reasonable return on plant. Furthermore, the plant is capital intensive and has a high level of ongoing costs. We have long seen that without some form of government intervention, the plant would be uneconomic. Origin will continue to utilise the site, through the construction of a 700 MW battery.
The impact the removal of this base load capacity on the broader NEM remains to be seen. Perversely, it may lead to more volatile prices – benefiting batteries and other on demand capacity such as gas peakers. We also think it’s too early to rule out that the government may intervene between now and 2025.
We continue to see Origin as well positioned to transition toward a capital light, technology focused retailer.

Property sub-portfolio

Company description: Industrial property group with operations that span development, ownership and management of global industrial property assets.

1H-22 Result:

Goodman’s result exceeded expectations – which was surprising given it had upgraded its profit expectations twice this year already.
The company can be broken down into a few components: fund management, property development and property investment (owned properties).
Property development: The market’s focus in general has been property development – which has a large pipeline of developments ($12.7b of work in progress) to be delivered over the coming years (approx. $7bn per annum). This part of the business surprised to the upside.
Property investments: The company saw further valuation increases (tightening cap rates) and strong property income growth driven by e-commerce demand.
Fund management: Assets under management grew steadily and performance-based fees were above expectations.

Read through for FY-22:

The focus in coming years will be the company’s ability to deliver and lease developments, particularly in an environment where costs are increasing.
The upside from fund management and property investments is likely to be more muted, with the cap rate compression story largely playing out. Income growth across portfolios will therefore play more prominence.

FY-21 Result:

URW is one of few retail property exposures we have in the property portfolio.
It is what we see as a very unique position: the REIT holds quality retail assets globally, including several flagship shopping centres across Western Europe (such as Carrousel du Louvre).
However, it went into COVID with a high level of debt, which was compounded by falling rental income and vacancies as the pandemic hit.
The REIT has therefore been slowly realising some of its assets to reduce its level of debt. The values realised have of course depended on its ability to reduce vacancies and the broader recovery of its retail assets across Europe and the US.
Its result in FY-21 was encouraging: vacancies in in its centres have dropped (particularly in the US), it has been able to transition to longer term lease deals at better rates and sales in its centres are recovering, often ahead of foot traffic (less customers, spending more).

Read through for FY-22:

The improvement in underlying trading, occupancy and leasing helps support values of properties URW is looking to dispose of in the coming years to reduce its debt (particularly in the US).
While the outlook for URW carries some uncertainty, the position provides a large degree of leverage to a recovery in trading conditions. If the company’s asset realisation plan is well executed, at reasonable values (and uncertainty around property values reduced) its current price should prove to be cheap.