Investment Matters

Profit Reporting Season Wrap

With August’s profit reporting season well and truly behind us, we have had some time to reflect on the results we saw across the market.

Across the market, it was a positive reporting season, with most companies meeting or exceeding expectations. However, the outlook for next year is much more subdued and will be dependent on a rapidly evolving landscape, namely the pace and degree to which there is an easing of lockdown measures.

Leading into profit reporting season we highlighted some themes we thought may important factor during August’s profit reporting season, including:

  • High expectations
  • Cost pressure and inflation
  • Dividend catchup and capital management
  • Transient or permanent?

We revisit these and how they relate to companies within client portfolios.

High expectations – revised downward

In aggregate, profits grew strongly in FY-21 off a low base in FY-20, with earnings per share (EPS) for the ASX 200 rising by 30%.

This was helped along by windfall profits for iron ore producers, as well as provision writebacks from the banks. This can be seen below, with almost 20% of the growth in earnings per share growth for the ASX200 index over this reporting season attributable to the high iron ore price.

While positive for profits in FY-21, this highlights to us some of the concentration risk investors face in investing in a market cap-weighted index (particularly in Australia) – with BHP set to become an even larger part of the index in the near term (approx. 10% of the index!).

FY-21 earnings propelled by iron ore and the banks

Iron Ore

Source: MST Marquee

Leading into profit reporting season we noted that earnings expectations in aggregate for FY-22 left little margin for error, in light of Covid uncertainty, patchy recoveries in many sectors, and uncertainty regarding monetary policy.

We subsequently saw the market downgrade FY-22 earnings expectations by 1.4% for the ASX 200.

There is still an expectation that earnings will grow by 15% in FY-22. As the chart above shows, expectations of a COVID recovery and a recovery in the energy sector are expected to do much of the heavy liftin. However, we also note this also bakes in an expectation that the price of iron ore remains relatively high (approx.. US $140 vs US$132.5 at present). We continued to be conservatively positioned.

Dividend catchup and capital management – still some caution

Leading up to reporting season, we noted that a sign of confidence would be the degree to which dividends are re-instated by companies.

In general, the dividends announced during Profit Reporting Season were strong. However, there was still a degree of conservatism when it came to dividend policies (i.e., a more permanent shift in the level of dividends paid – given the uncertainty around the pandemic).

The strong balance sheets built by companies over FY-20 saw many companies announce they were returning significant amounts of capital to shareholders. This was primarily in the form of buybacks and special dividends (i.e., less ‘permanent’ shifts in capital management policies)..

This may be a sign that generally companies see their balance sheets are in good health and are gaining confidence.

Several companies across client portfolios announced they are returning capital to shareholders including:

- Woolworths –a higher-than-expected final dividend and larger than expected A$2bn off-market buy-back (after the recent demerger of Endeavour group).

- Viva Energy - $100m capital return and on market buyback after resilience during COVID, government support and stronger cash flow from refining. This came with the announcement of a new dividend policy, with separate dividend policies for Refining and Retail, Fuels and Marketing segments.

- Paragon Care – reinstated its dividend (3% dividend yield at current price) after successful debt renegotiation and significant improvement in operating cash flow.

- Emeco – has reinstated its dividend and an on-market buyback announced after significant reduction in debt/leverage over the past few years.

- Here, There and Everywhere – has an ongoing on-market buyback.

- NAB – announced an on-market share buyback of $2.5bn after the unwind of COVID related provisions.

Cost pressure and inflation – evident across the board

Leading into reporting season we were wary of rising cost pressures and the impact this may have on profitability.

This was emerged as a clear during the August Profit Reporting Season. This is demonstrated in the chart below, which highlights the proportion of net negative (or positive) citations by ASX 300 companies on revenue and cost items over time:

Rising freight and labour costs evident from company commentary

Frieght and labour

This impacted several results from companies in client portfolios and was a focus of our subsequent discussions with the management.

However, we saw that in many instances these costs were able to be passed on. This included:

  • Reliance Worldwide - rising copper costs to be recouped through price increases
  • Cardno - labour costs largely stable, with the company confident in passing increases through becoming price ‘maker’ vs ‘taker’ given current demand.
  • United Malt - rising freight and barley costs contractually passed on to customers
  • Viva Energy – lower volumes and rising oil prices balanced by rational pricing across the industry
  • Here, There and Everywhere – talent costs largely fixed due to recent major contract renegotiations.

We remain focused on orienting the portfolio towards companies that can preserve wealth in an inflationary environment.

Transient or permanent? – Impact of COVID continues

We noted that the August reporting season will begin to reveal the degree to which the impact of COVID has resulted in a permanent change in the corporate landscape.

This includes:

  • The extent to which the increase in activity over the past 12 months leads to permanent changes to revenue, versus a transitory ‘blip’
  • Whether cost pressures that have been seen will be ‘transient’ or more permanent.
  • The degree to which changes made during the depths of the crisis will result in permanent efficiencies and improvements in costs.

However, with recent lockdowns, uncertainty remains for several companies, with an estimated 16% of companies not issuing guidance due to COVID (Source: Macquarie). This remains a risk to earnings in the near term.

While borders remain closed, some COVID beneficiaries continued to benefit from current spending trends for longer than expected. Retail stocks for example generally posted stronger than expected sales.

‘COVID losers’ likewise continued to be impacted, with the delta variant resulting in downgrades for several companies – however downwards earning revisions were nowhere near as severe as they were as the pandemic hit (clients’ exposure to these ‘COVID losers’ is now relatively limited).

Overall, the cost savings and efficiencies that will be carried beyond COVID has been difficult to gauge with the impact of COVID is still clouding results.

Despite this, we have seen some signs that some of the learnings from COVID will translate to permanent changes and savings for your companies.

This includes:

  • Worley – global support costs have remained low (reduction in travel-related expenses, consolidation of property leases)
  • Cardno/Intega – improvement in collections (days sales outstanding or DSO) has continued.
  • Paragon Care – Consolidation of warehouse space has led to an approx. $1m reduction in lease costs and a lower cost base.
  • Reliance Worldwide – Greater supply chain efficiency, expansion of manufacturing footprint.
  • Earlypay – leaner administrative staff facilitated by technology (Skippr), expansion of salesforce.
  • Viva Energy – government support of refining operations and reduction volatility of earnings.
  • MMA Offshore – expansion into other sectors outside of oil and gas such as renewable energy (wind farms)

Your Companies – a summary

A snapshot of the results from your companies over the August Profit Reporting Season is provided below.

Further commentary on each result can be found by clicking on the link associated with each company:

Company Price reaction on the day of result Rating
Aristocrat Leisure Reported in May
ANZ Group Out of Cycle - to report in November
Aurelia Metals Miner - see Quarterly Activity report commentary
Carbon Revolution 9.0%  4.5 ⭐
Cardno 5.4%  4.5 ⭐
Costa Group 4.4%  3.5 ⭐
Endeavour Group -2.2% 3.5 ⭐
Earlypay (CML Group) -2.9%  4 ⭐
Emeco  -5.0%  3.5 ⭐
Hastings Technology Metals Miner - see Quarterly Activity report commentary
Here, There and Everywhere 6.8% 4 ⭐
IGO Group Miner - see Quarterly Activity report commentary
Incitec Pivot Reported in May
Intega 2.0% 4 ⭐
Jervois Mining -2.0%  3.5 ⭐
Lovisa 17.6%  5 ⭐
Lynas Miner - see Quarterly Activity report commentary
Magellan Financial Group -10.2%   3.5 ⭐
MMA Offshore 0.0%   3.5 ⭐
NAB Out of Cycle - to report in November
Newcrest Mining Miner - see Quarterly Activity report commentary
Northern Star Miner - see Quarterly Activity report commentary
Origin Energy -4.1%  3.5 ⭐
Paragon Care 3.5% 4 ⭐
Pushpay  Reported in May
Perpetual -0.9%  3.5 ⭐ 
Platinum Asset Management -9.6% 3.5 ⭐
QBE Group 8.1% 4 ⭐
Reliance Worldwide -4.0% 4 ⭐
Sandfire Resources Miner - see Quarterly Activity report commentary
360 Capital 0.6%  3 ⭐
Threat Protect 0.0%  2.5 ⭐
TZ Limited 5.0%  3 ⭐
Viva Energy -0.5%  4.5 ⭐
Worley 2.0%  3.5 ⭐
Woolworths 0.4%  4 ⭐