Profit reporting season: Week 1
This week, profit reporting season began in earnest, with over 29 companies reporting.
Amongst the first wave of companies to report, and providing a modest start to our reporting season, were five companies within client portfolios.
While several companies reported, CBA’s result has garnered the bulk of the market focus.
As the first bank off the rank, its result provided an insight into the health of the banking system and broader economy.
CBA (positive impact) – 1.5% on the day of the announcement
What CBA’s result has revealed is that market conditions have continued to improve, with deferrals declining significantly - only $9 billion of the housing loans (initially $51 billion) and $0.3 billion of business loans (initially $16 billion) remained on deferral.
Loan impairment charges were also significantly lower than the previous half, a reflection of reduced arrears and the improved outlook.
Volume growth was good, particularly in housing, with some momentum in the business.
An interesting highlight was the doubling of trading volume on the company’s retail investor platform – CommSec, with over 230,000 accounts opened in 1H21. This again reflects the increased retail activity we believe the market has seen over the past 12 months.
However, the result was also a reminder that banks are operating in a very different environment to a decade ago, with higher expenses in technology and a continued decline in net interest margins in the current rate environment.
Client’s portfolios own NAB and ANZ, banks we see as less richly priced as CBA and provide more leverage to a complete recovery and a business-led growth in lending.
IAG (positive impact) +4.5% on the day of the announcement
IAG delivered a good result with strong underlying margins and reasonable premium growth (commercial insurance being a highlight).
The company benefited over the half from a reduction in motor insurance claims, with a lower frequency of claims during the lockdown period.
Importantly, the company has not added further provisions for claims it may be liable for under Business Interruption insurance relating to COVID. It outlined the methodology for what it sees as a conservative estimate of the costs it may occur.
With respect to longer-term profitability, the company outlined a broad strategy to target an uplift in margins through a range of measures including technology improvements, a stronger customer focus and remediation of underperforming insurance lines.
Boral (negative impact) -7.4% on the day of the announcement
Boral delivered a reasonable profit number, although this was largely driven by non-core or divested businesses.
The result provided us with a reminder of the strong leverage Boral provides toward infrastructure spending, with both the US and Australia’s need to catch up on decades of underinvestment in infrastructure.
A drop-off in infrastructure projects and roll-through of price changes hampered Boral Australia’s result, although it benefited from the buoyant market for detached housing.
While the remainder of FY-21 is expected to be weak, management anticipates a growth in infrastructure activity to improve profitability in FY22.
Boral North America’s result was impacted by lower fly ash revenue, which is largely supply-led (sourcing has become more challenging given the roll-off of a key supply contract and, more broadly, a reduction in coal-fired generation) although the company is exploring strategies to improve sourcing. Building material products surprised on the upside. The company is still assessing the sale of part or all North American assets, including fly ash.
Importantly, the company announced one of the outcomes of the strategic review process it began last year. It outlined an operational improvement plan expected to benefit operating profit by $300 million on an ongoing basis over the coming years (net of inflation).
We are wary of ascribing this value to the company as this is the latest in a series of cost out attempts over the company’s history, however, there is still potential to achieve better returns from Boral’s assets.
Emeco (negative impact) -8.1% on the day of the announcement
Emeco delivered an operating profit that was in line with its guidance, however, the result had more moving parts than we would like, with several accounting adjustments.
Activity in the Eastern division (which primarily services coal miners) was weaker than expected, hampered by weak pricing Chinese import restrictions on coal. However, this was offset by stronger activity in the West with strong iron ore and gold prices.
Reacting to this, Emeco will look to relocate significant amounts of equipment to the West to take advantage of the growing opportunities in Western Australia, as exports remain strong and the company continues to diversify away from coal-related revenue.
The newly acquired business in Pit N Portal continues to perform well, with strengthening earnings expected as new projects ramp up, including the Mincor nickel project.
With metallurgical and thermal coal price recovering, the company anticipates new contracts to begin in the Eastern region towards the end of the financial year, as well as continued improvements in utilisation of equipment in the West.
Emeco is now in a significantly improved position with respect to its debt, after a recent capital raise which we participated in. The company intimated that it has the flexibility to pay a dividend in the near term as well as fund future growth opportunities.
We met with the company and look forward to Emeco further demonstrating its cash-generating ability to the market in the near term.
This ability will be better demonstrated in strong market conditions, where Emeco offers commodity producers the ability to ramp up production or begin production in a capital-light fashion.
Newcrest Mining (positive impact) +4.1% on the day of the announcement
Newcrest’s presentation for the first half of the fiscal year 2021 was pleasing.
The highlight was revised production forecasts from its second-largest mine, Lihir.
Lihir is a technically challenging mine, situated on a small island in Papua New Guinea. Production challenges have recently weighed on the company’s share price.
Pleasingly, however, the company revealed that production from Lihir forecast to be better than expected, with the impact of clay dense ore likely to be lower than expected. This, along with an adjusted mine plan has led the company to project higher production than previously expected as well as higher grades.
The company is also progressing its growth options and future pipeline of projects in Haverion and Red Chris, with early works for box cuts and exploration declines at both sites.
We see that a material discount continues to be applied to these mines, a discount we expect to unwind as these projects progress and the market gains more comfort in the resources present, mine plans and project economics.
Given the company has significantly reduced its leverage over the past few years, it has announced a new dividend policy – which will see it pay out between 30-60% of free cash flow generated. For the first half of 2021, this will result in a dividend of 15 cents per share, double the previous dividend of 7.5 cents per share.
Newcrest continues to be a long life, low-cost producer that provides the portfolio with an exposure to the price of gold.
The above market commentary represents the views and opinions of First Samuel Pty Ltd. Such market commentary contains information of a general nature only. Such market commentary is not intended to provide a sufficient basis on which to make any investment decision and should not be taken as such. It has not taken into consideration your objectives, needs or financial situation. Before making decisions in relation to any financial product, you should always obtain and read any relevant Product Disclosure Statement or information statement and seek personal financial advice.