This week: ASX v Wall Street
FYTD: ASX v Wall Street
Company Profit ‘Reporting Season’ preview
Many companies with 30 June financial year ends (over 2,000 listed companies) will present their FY-23 financial results to the ASX in August.
It’s an intense time of year for equity market professionals. But one that is welcomed because of the opportunity to review financial data, hear about company strategy, assess management and operational performance, and to review one’s own stock selection and analytical prowess.
Recent ASX200 share price performance would suggest that market expectations for the earnings outlook remain quite constructive. The ASX 200 is up 5.3% in 2023, having been assisted by an expectation that we are nearing the end of Australia’s interest rate hiking cycle. And that the rate of core inflation in the economy is slowly heading lower toward the RBA’s preferred band of 2-3% p.a.
As our Australian shares sub-portfolios currently stand, we are fairly conservatively positioned. We have a relatively large holding in cash in addition to several stocks that are subject to takeover bids, which limits our downside risk.
Earnings estimates – trend is not an investor’s friend in calendar 2023
Frequently, ‘sell-side’ analysts (i.e. from stockbrokers) often prove to be an overly optimistic bunch in terms of their expectations for company earnings. With promises of growth from company executives ringing in their ears, analysts tend to have stronger growth forecasts than what actually comes to pass once the financial results are reported in August.
Figure 1: ASX 300 Consensus EPS
As you see from Figure 1 in orange, most the time since 2002, earnings per share estimate revisions are negative (below the line).
Figure 2: Change in ASX 300 Fwd EPS (%mom)
Source: FactSet, Macquarie Research
While calendar 2022 proved to be the exception to the rule that earnings are continually downgraded, with analysts having to consistently upgrade earnings as low interest rates and a re-opening economy proved a powerful force, Macquarie’s Equity strategy team notes that earnings estimates for the ASX300 have been downgraded by 6.6% YTD, including in consecutive months in June (-3.4%) and July (2%). See Figure 2, the two right hand bars.
The Macquarie team also recently highlighted the correlation between the NAB Forward Orders data (advanced 3 months) and the outlook for economic activity (and consequently forward EPS estimates for industrial companies). See Figure 3, below.
Figure 3: NAB Forward Orders Lead Changes in All Industrials EPS
Source: FactSet, Macquarie Research
A tough near-term outlook for equities?
We believe given a combination of:
- Strong share price performance for the index over calendar 23;
- The likelihood that earnings estimates will need to be trimmed further; and
- Diminished liquidity in the market beyond the largest 50 stocks that..
there may be a savage response to companies that disappoint on earnings (and the tone of their outlook statements) throughout reporting season. Hold on to your seat, people!
Sandfire Resources (SFR)
June 2023 Quarterly – released 27 July
Sandfire Resources is currently the largest aggregated exposure across client portfolios following a strong rebound in share price, a good deal driven by the recent update. We believe it is the best way to have exposure to copper, which is one of the key metals used in the electrification of vehicles.
We would remind readers that the next 12 months are exciting for Sandfire. MATSA, the company’s most significant asset in Spain, is now bedded down; management is now focusing on culture, resource growth, and mine management. The new CEO, Brendan Harris, is a respected figure in the industry who will likely make his mark in the next 12-18 months.
Recent updates have included fewer surprises for the market, and significant risks that initially surrounded the purchase of MATSA are losing relevance.
FY-24 will be all about how well the new mine in Botswana can be delivered, the early results of its operations, and the options that Sandfire has to expand its presence in the region.
The exiciting news from the recent update included more information about the progress made at Motheo, as ongoing investment is now moving towards production (“ramp-up”).
What the market said
“We viewed FY24 guidance as the most important part of their release and it was ahead of market expectations. Here the Motheo ramp-up is going better than the market expected. The project has been delivered on time and budget, atypical in the mining industry – a credit to the project team. This new mill has been commissioned into a comparatively underexplored region for which Sandfire has large tenement holdings. (UBS Equities)“
“better quarterly…and still the best way to play copper …. What was really clear looking at this quarterly today is that the FY24 guidance is well ahead of expectations as the Motheo ramp-up is better than expected. They are now talking to 97kt of copper being produced which is about 8% ahead of us and 5% ahead of consensus. And the FY25 outlook of 110-120kt of copper is about 7% ahead of us. (Macquarie Equities)“
Owning a copper producer also entails viewing the copper price and its likely volatility. The long-run outlook certainly supports higher copper prices than current levels. Electrification demand has more than a decade to play out; new copper mines are rare globally, with the quality of new mines falling and their production costs rising.
But there are also short-term downside risks. These risks would include a slowing Chinese or global economy.
The degree to which the downside price movements affect a miner relates to the miner’s cost of production and the amount of non-mine overheads or financial gearing it has.
To have the confidence to build a larger portfolio position in a mining company, that company should have relatively low production costs. The lower the production costs, the higher the margin in good times, and the more likely the mine will be able to maintain profitable operations during low commodity prices. Figure 4 below shows recent moves in the global copper price per pound. These prices can be volatile, but that volatility shouldn’t impact production schedules for a high quality copper mine.
Sandfire satisfies this requirement. MATSA has a low cost of production, and it is anticipated that Motheo will also have a cost base that supports mining within a range of copper price environments. This sets Sandfire apart from a range of smaller copper companies with much more leverage to copper prices.
Proving the lower cost and low-risk production characteristics of Motheo over the next 12 months will likely add significant value to the business.
The importance of the new Motheo production can be seen in Figure 5 below, which outlines likely production for the group to 2030. Note that in the outer year, an additional asset, Black Butte (in the USA), is anticipated to come online. Having had high hopes for Black Butte for over a decade but continually thwarted by environmental concerns, the market is not yet attributing much value to this mine. Black Butte will prove an excellent addition for First Samuel should it eventuate, but it isn’t core to our investment thesis.
Figure 4: Price of Copper
Figure 5: Copper Equivalent Production
Source: Market Index, Sandfire Resources, UBS