Investment Matters

Reporting season wrap

This week we provide our bi-annual wrap of reporting season – both our thoughts generally, and specifically in relation to your investments.

But first, some admin – two companies released their results not quite in time to make last Friday’s IM edition: Moreton Resources and Threat Protect.  Their summaries first:

Moreton Resources reported a one-off gain (which was recognised as revenue, and flowed through to profit, in FY-18).  The gain was the value of assets it acquired as part of the purchase of the Texas (NSW) silver mine (comprising plant and equipment, mine infrastructure and inventories [silver in leach heaps]), less the purchase price.  It should be noted that Moreton also acquired the environmental obligations of the mine, for which it has established a cash bond.

The company continues with the commissioning of the Texas silver mine, and development of various prospect mines in its portfolio.  Thus, it did not generate operational revenue or profit in FY-18 (or FY-17).

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Threat Protect’s financial numbers for FY-18 look worse than the performance of the underlying business. 

There were a number of one-off costs in FY-18 that were incurred as the business expanded.  These included acquisition costs of $1.65m, impairments of $1.13m, and one-off income / gains (which were higher in FY-17 than FY-18).  Without this, earnings were $867k vs $1.20m in FY-17.

Operating revenue increased 28% to $14.6m.  The area of the business driving future growth, security monitoring, had a 64% increase in revenue, with ~83,900 connections at 30-Jun-18 (vs ~47,300 at 30-Jun-17).  Revenue from the guarding division was flat, but on a lower margin.

The growth in the monitoring division is expected to drive revenue to be greater than $17.0mill in FY-19, with underlying earnings to more than double (EBITDA $3.8m to $4.0m vs the company’s underlying earnings FY-18 figure of $1.4m – but this figure excludes share-based payments which we don’t exclude).

Now to the wrap of the recently concluded reporting season:

General thoughts

Overall reporting season was solid, with good earnings growth generally.

Versus expectations (which is what drives share price reactions) analysis by Morgans indicates that large caps (ASX50) had mostly 'in line' results.  19% of companies disappointed the market, and only 4% beat expectations (which is lower than normal).  Mid caps (ASX300 companies, excluding those in the ASX50) results were more in line with history, with 20% of results beating expectations and 20% disappointing (the remainder in line).  As per the norm, those who disappointed were punished.  Examples include G8 Education, Domino’s Pizza and Ramsay Healthcare.

Profit outlook was a little damp overall.  Whilst good earnings growth is still forecast for FY-19, it was revised down on average (Morgans indicates 0.7% lower to 7.2%, excluding resource companies).  This is the E component of P/E, and thus is not ideal given the valuation of the market (All Ordinaries) is a toppy P/E of 16.7x (at end Jun-18, vs long term average of 15.0x, source: marketindex.com.au).

This reporting season was notable for the differentiation between value and growth stocks.  Investors have not been afraid to continue to pay up for growth.  We haven’t noted this for a number of years (value stocks are normally greater beneficiaries during reporting seasons).  And certainly not to the extent we saw this reporting season.  It is a little bit of a worry, as we see it as further confirmation we have a frothy market currently.

Notable sectors were the banks and miners.  Earnings growth from the banks was negative on a per share basis, and the outlook is soft.  Miners delivered strong earnings growth, and dividends – commodity prices were generally pretty high, and production levels that were mostly flat but strong (and under future pressure for some companies and commodities).  It will be interesting to see whether commitment to investment (internal expansions / regeneration, and acquisition) steps up over the coming year.  Additionally, companies with an overseas exposure had (generally, but with exceptions) very strong earnings growth.

So overall: it was a quite good reporting season, but with some caution as we look forward.

Your equity investments

The table below summarises how each of your companies performed vs the expectations of your Investment Team.  Please refer to recent editions of IM for a results summary for each company.

Overall, financial results from the recently concluded reporting season were acceptable for the companies in your equity portfolio.

Earnings from the large caps – Primary, Pact and Origin Energy - all disappointed.  Pact in particular with little forewarning.  This led to quite sharp mark downs in the share prices of Primary (-18%, but they also conducted a capital raise), Origin (-19%) and Pact (-24%).

Positive results came from HT&E (the radio business [remaining post sale of Adshel] looked good; share price +18.5%), Southern Cross (radio also looks good: +9.5%) and QBE (+9%) helped somewhat to balance the ledger.

When viewed through the prism of dividends, we had good results from South32, Suncorp, Primary Health Care and BHP.  Whereas we were disappointed by HT&E (albeit with the sale of Adshel now approved a big dividend is coming), and Origin Energy (they steadfastly refuse to pay a dividend yet!).  We had been looking for +4.2% dividend growth H2 FY-18 vs H2 FY-17.  However, the final result was +1.5%.  This was entirely due to Origin holding out.  Had it paid what we forecast we would have seen +5.3% growth, i.e. marginally better than expected.

We remain focused on buying businesses that can grow and are not expensive.  Whilst short term results have disappointed, in the end, the law of gravity will kick in and we will benefit once again.

Currently, your equity portfolio has circa 18% cash, and a neutral bias (between growth and defensives).  The portfolio remains inexpensive (at 10.8x P/E), with really good growth (>10% average earnings growth p.a. for the next three years) and reasonable dividends (at 5.0% p.a.).  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 18, albeit it won’t be linear, as always per usual.