Investment Matters

Market Themes

Despite reporting season coming to an end, there was ample market activity this week, with headlines dominated by the fall in the NASDAQ on Friday (last week) and Tuesday.

This was precipitated by a selloff in technology stocks, which blunted their rapid rise and spilt over to the broader US market and the ASX. Both markets began their recovery during the latter half of the week, however, volatility remains elevated.

With the return of volatility comes a reminder that we are in a divergent market.

This has manifested not only in a large divergence of opinions, but a divergence in the performance of different types of stocks (particularly those typically characterised as “value” and “growth”) as well as pockets of exuberance, coupled with pockets of value.

Your portfolios have had low exposure to many of the companies that have shown exuberant returns over the most recent period and have had a ‘value’ stock focus.

There is very little exposure to ‘tech names’ in your portfolios today and the Australian Equities Portfolio carrying more than 14% cash. We have been cautious: selling holdings in stocks that we felt have rallied too hard over recent months, including strong portfolio performers.

Most listed companies will go radio silent over the coming weeks, having had their moments on stage during reporting season.

With the market entering a state hibernation, we look back on the last four weeks to highlight some themes that emerged during this reporting season.

Theme #1: More hits than misses

Leading into reporting season expectations were muted, particularly for companies that had withdrawn their guidance for profit.

And while earnings contracted significantly, results were generally better than feared.

This was largely due to low expectations and earnings generally falling less than expected (Source: Macquarie).

This would indicate that a significant fall in profits had already been priced in, with the nature and speed of the recovery a bigger focus.

What was also notable was that 41% of companies that withdrew their guidance still managed to post results within 5% of their pre-pandemic expectations (Source: Macquarie).

This indicates the impact on earnings was less widespread, as was certainly the case for several of your companies.


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Theme #2: Less spare change

“We expect this pragmatic approach [suspension of dividends] to capital management will not only allow us to continue to thrive through the pandemic, but will also allow us to exit the pandemic with significant financial flexibility to support our growth agenda”
-    Jason Miele, CFO, James Hardie

This was the general sentiment expressed broadly across the market.

As anticipated, dividends were conservative, as companies looked to preserve financial flexibility and strengthen their balance sheets.

Macquarie estimates that 67% of companies in its coverage reduced or suspended their dividend.

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The overall market (ASX200) of course, is heavily influenced by lower dividends from the banks. Furthermore, payouts by miners were weaker, despite buoyant commodity prices (namely copper, iron ore and gold).

 

Theme #3: Corporate CrossFit: a leaner ASX?

What also emerged during reporting season was an intense cost-cutting discipline across a wide range of companies.

This manifested in a range of measures including corporate restructurings, reduced capital expenditure, a reduction in corporate overheads (office space, flights and perquisites) and importantly much stronger working capital discipline.

We saw several examples in your portfolio, including much better working capital management by Worley, as well as Cardno and Intega. All delivered strong results, boosted by this discipline.

And so, the question we are left asking is the extent to which these changes in corporate behaviour and cost benefits will be carried over and maintained as activity rebounds. There will be sectors that stand to benefit (as we have seen with video conference platforms) and similarly lose out (for example, the corporate travel sector) as a result of these changes.

Theme #4: The power of the government purse

We also saw the power of the government purse, particularly when it can put money directly in the hands of consumers (JobSeeker, JobKeeper, HomeBuilder and the like) boosting household disposable income.

Companies directly benefited from JobKeeper subsidies and rental relief.

They also benefited indirectly from income support for consumers. This manifested in strong retail spending, with Increased spending on home improvement and home goods. This was reflected in strong results from consumer discretionary stocks including JB-Hifi, Nick Scali and Wesfarmers.

Your portfolio benefited from this through exposure to Bapcor, which saw a strong rise in sales, particularly in AutoBarn.

Government support has also been positive for the housing market more broadly.

Subsidy programs such as JobKeeper, coupled with lower interest rates, a trend towards de-urbanisation has led to strong housing activity both locally and abroad (particularly in the US).

Your portfolio benefited from its exposure to housing, through Reliance Worldwide. James Hardie and Stockland (for those with an allocation to Property) which all performed strongly.

Continued support will be critical as the economy emerges out of the crisis, with this reporting season demonstrating the power of direct fiscal intervention.

Theme #5: Racing up the S-curve?

We have also seen a dramatic pulling forward of gradual changes in consumer preferences and habits.

This includes an acceleration in the penetration of e-commerce (pulling forward several years of growth), de-urbanisation (particularly in the US, with more people moving to the suburbs) as well as a greater shift to working from home.

Whether this leads to a permanent shift is yet to be determined and so to the degree and extent to which recent activity can be extrapolated.

This is critical in assessing the value of companies that have both benefited (such as Kogan, Redbubble, Accent Group) or have been negatively impacted (such as Flight Centre and Crown Resorts).

We hold a small exposure to companies where we see that this magnitude of this change has been exaggerated or excessively extrapolated.

Theme #6: Greater confidence, but caution remains

While companies, in general, expressed greater confidence, they remain cautious, as evident by dividend policies and future spending commitments.

More than 60% of the market has not given earnings guidance for next year (Source: Macquarie).

This is particularly the case for banks. While bank provisioning has remained modest, it remains to be seen how their loan books will be impacted by the gradual removal of government support. However, priced at decade lows, and with future benefits likely to flow through from cheaper funding, we still see merit in a modest exposure.

Ongoing company trading updates and the AGM season are therefore going to be important in the months ahead.

Australian Equities portfolio: Company Result Scorecard

The table below provides a summary of the result from your companies.

Overall, the results from your companies were pleasing under what were difficult conditions. The Australian Equities Portfolio outperformed the broader market during the Reporting Season period.

We were particularly impressed by the results from:

  • Bapcor who benefited from increased consumer discretionary spending
  • Cardno and Intega, who grew profits while improving working capital management.
  • Worley which delivered a result that was ahead of expectations, due to strong cost-cutting discipline.
  • James Hardie who showed strong growth, gained market share while benefiting from an upturn in US housing activity.
  • Reliance Worldwide, which delivered a strong result, particularly in the US, despite COVID related challenges in other regions.
  • Mineral Resources which showed strong increases in production, good returns on capital and benefited from a rising iron ore price.
  • Viva Energy which maintained strong profitability, despite a reduction in the volume of fuel sales.

For further detail on individual results, please see previous week’s publications of Investment Matters. 

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