Investment Matters

Themes this reporting season

August is the time when your Investment Team hunkers down for the all-important Profit Reporting Season.

Over the next four weeks, our pens (or rather, our spreadsheets) will be at the ready, assessing your companies’ operating performance against our scorecard.

In turn, the market will be making its own assessment – a scorecard of our stock-picking over the year.

Of course, our focus remains on the individual companies our clients own and several where we see opportunity.

However, given the unique year that has been, there are likely to be some common questions and themes that arise during the FY-21 profit reporting season.

We detail some of these below.

Theme #1: Cost pressure and inflation

A key theme in profit reports over the year has been rising cost pressures and inflation, with bottlenecks and delays throughout global supply chains

This includes “rumors” of a shortage of labour in Western Australia, elevated shipping rates, global semi-conductor shortages and rising commodity prices.

There will therefore be a focus on the degree to which companies can offset these costs (e.g. through pricing or volume) and how cost pressures have and will impact what are historically elevated margins.

Shipping rates unanchored

Shipping rates unanchored

Source: Morgans

Theme #2: A return of confidence?

As COVID hit, uncertainty was rife.

This saw many companies withdraw their guidance to the market (that is, their forecasts for profits).

This continued at the half-year profit results (February), with several companies electing not to guide towards a profit number for FY-21.

A key sign of confidence during this reporting season will therefore be whether companies provide guidance for profits in FY-22 and where these forecasts land.

This of course, will be heavily influenced by recent lock downs.

In addition, companies significantly curtailed spending as the pandemic hit. The degree to which there is a resumption of large capital investment programs will therefore also speak to the level of longer-term confidence amongst corporates.

Theme #3: Dividend ‘catch-up’

Another sign of confidence will be the degree to which dividends are re-instated by companies.

As the pandemic hit, companies went into a mode of cash conservation, which saw them cut dividends.

This has eased over the first half of the year, with the aggregate level of dividends paid across the ASX 200 recovering to 2019 levels.

However, these dividends have been supported by bumper payouts from miners.

Furthermore, the aggregate percentage of profits being paid out remains below pre-pandemic levels – 70.5% vs pre-pandemic levels of 75% (Source: Morgans).

The extent to which dividends are re-instated will therefore be another marker of confidence amongst companies.

Dividends have caught up to 2019 levels – but expectations beyond FY-21 remain low

Dividends

Source: Morgans

Theme #4: Barbarians at the gate?

Our expectations of a large uptick in merger and acquisition activity (see M&A activity on the rise) have played out, with a huge wave of activity seen across the market.

Examples in recent months include a potential merger between Oil Search and Woodside, as well as bids for IRESS, Afterpay, Hansen Technologies and Altium (amongst others).

With a return to confidence and a large amount of capital looking to be put to work globally, we would not be surprised to see more activity over the August reporting season.

This includes companies looking to grow inorganically through large or bolt-on acquisitions as well as private equity takeovers.

Theme #5: Transient or permanent?

The question of transient or permanent is one that can be applied to many aspects of the economy post COVID.

With respect to costs, we saw some significant shifts as companies tightening their belts in the first half of the year.

This included a stronger focus on reducing working capital, a reduction in discretionary expenses such as travel, headcount reductions and a consolidation of office space.

August reporting season will begin to reveal the degree to which learnings during COVID have resulted in permanent efficiencies and improvements in costs.

In terms of the ‘top line’, several companies have benefited from a disruption in supply chains, a rapid rebound of activity and reallocation of spending in the economy.

These include iron ore producers, those in the consumer discretionary sector (particularly retailers) and producers of building materials

The extent to which the increase in activity over the past 12 months leads to permanent changes to revenue, versus a transitory ‘blip’ will therefore also be in sharply focus.

Theme #6: High expectations

In FY-20, the profits of the broader market collapsed by 35% (ASX100).

The market has high expectations of a rebound leading into this reporting season, with significant earnings growth amongst miners and other larger companies (ASX100) expected in FY-21 (+49%).

Furthermore, significant growth in earnings is expected in FY-22 (+9%) (Source: UBS). Markets are notorious for over-estimating earnings in 12-18mths time.

Much of the focus this reporting season will be on companies’ outlook statements, with earnings in FY-22 expected to return to their pre-covid peak (see chart below).

Covid uncertainty, patchy recoveries in many sectors, and uncertainty regarding monetary policy, increase the likelihood FY22 expectations are over inflated.

Yet overall market indexes are at much higher levels than March 2020 – i.e. the markets P/E ratio has expanded. This leaves little margin for error.

We are conservatively positioned leading into this reporting season, having built our cash levels over the past few months. Individual companies that disappoint will provide good buying opportunities.

Earnings in FY-22 expected to top their pre-COVID peak

Earnings

Source: Morgans