Investment Matters

Company Profit Reporting season wrap-up

General thoughts

The FY-17 reporting season was a tepid affair, with a net 2% downgrade for FY-18 EPS recorded across the ASX by analysts.

When compared to expectations leading into reporting season 51% of companies beat prior forecasts, which was slightly below the long-term average (52%).  Only 40% of companies saw analyst upgrades for FY-18 (versus prior expectations), versus around 45% typically experienced.

Standing back from this noise, the aggregate earnings of the market lifted +20% for FY-17, as compared to FY-16.  This was largely due to a +140% increase in resource company profits. 

With resource profits expected to be flat for FY-18 (based on current spot prices), 6% expected growth from industrials, and 3% from banks (versus the 8-9% growth recorded in FY-17), the overall expectation for FY-18 is for 6% earnings growth.  This is down from 8% expected prior to reporting.  Analysts are thinking things will get tougher, from an earnings perspective, from here.  Thus, conviction is notably low.

Specific observations

  • Companies are showing some signs of increasing investment, with the tide seeming to turn on the short-term-dividend-maximisation focus.  Some of this investment will be catch-up, after the focus on cash generation in the recent past.
    • Examples include CSL, Suncorp (IT investment), and Amcor (via acquisitions).
    • There was a negative market reaction to this in many cases, which we consider short-sighted.
  • Slight misses were punished (big share price falls), reflecting the toppy valuations of many, especially large-cap companies.

  • Miners, especially the bulks (iron ore and coal), produced more cash than they know what to do with, e.g. Fortescue.

  • Challenged sectors were insurance, and discretionary retail (excluding anything residential facing).  Although, in relation to the latter, some with a unique positioning or other successful strategy did well e.g. Kathmandu, Lovisa.

  • Guidance for FY-18 was sorely lacking, which we believe reflects the uncertain conditions faced in many industries.

  • The notable disappointments were Telstra, Domino’s, Bluescope Steel, Healthscope, and IAG.

First Samuel clients

First Samuel clients enjoyed a +13.9% increase in dividends in FY-17.  This is slightly above the +11%p.a. 10-year average.  This was another great result and shows the continued strength of the companies in which we invest.

Given the +20.6% increase in capital value over the past 12 months (which was faster than the dividend growth) the dividend yield of the portfolio has, however, fallen in FY-17 as compared to past years.  It currently sits just below 4%.

With the expectation that several of our large dividend payers will be redeemed or restructured, the hurdle for FY-18 dividend growth will be very high and difficult. Furthermore, the +23.6% cash position reduces potential income in the short term - as we struggle to find good growth and income (particularly as you go up the market in relation to company market cap, or size).  We are currently expecting a similar dividend level in FY-18 as FY-17.

A table has been provided below, which summarises how we viewed reporting season for each equity holding that recently reported.  Further information is contained in the recent editions of Investment Matters.

As we exit reporting season…

Ending reporting season, the average client's share portfolio has 23.6% cash and a neutral bias (between growth and defensives).  We are, however, still finding some places to invest and would expect that cash level to stabilise around here, as the portfolio resettles. The portfolio remains inexpensive (at 10.0x PE) with excellent (now lifted post FY-17 reporting) growth (+11.0% expected earnings growth p.a. on average for the next three years), and reasonable dividends (at 4.0% p.a. rounded up!).  Broadly speaking, with this construction, we would expect that we will deliver fairly similar growth in the next 3 years as we have in the last 17, albeit it won’t be linear, as always.