Rudi’s View: February Focus On Resilience & Dividends

This story features AUDINATE GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: AD8

In this week's Weekly Insights:

-February: Focus On Resilience & Dividends
-February Results Thus Far
-Corporate Australia Showing Resilience
-Commodities –  Lithium & Dividends
-Consumer & Gaming Stocks
-Advertising & Media
-Insurers
-Research To Download: Edison Research
-Research To Download: Research as a service (RaaS)

February: Focus On Resilience & Dividends

By Rudi Filapek-Vandyck, Editor

Financial markets are supposed to be forward-looking.

This is where the ambiguity begins, and the difficulty to understand what is happening, and why.

Those among us who have been watching markets for a long while know the supposed forward-looking dynamic is far from perfect. Whether it works or not is mostly dependent on from which starting point our observation begins.

Global equities have rallied hard since September last year, but equities have, effectively, front-run corporate earnings and fundamentals. This need not be a problem as fundamentals can catch up, assuming this is what happens next.

The problem with this bullish view is that economies are slowing, and they are almost guaranteed to continue slowing as the year progresses. Central banks are still hiking rates and the real impact from last year's tightening hasn't fully impacted just yet.

Hence, it's not difficult to see why so many observers and market watchers are skeptical whether indices can hold on to their gains. Corporate profits are under pressure because economic momentum is deflating, but also because cost inflation is still very much a negative feature.

If we stick to the positive thesis, history shows share prices start anticipating the trough in earnings well before that trough is in place. This forward-looking dynamic is shown in the graphic below (courtesy of Janus Henderson).

To read the graphic: bars in orange show the time it takes for investors to de-rate share prices (via contracting PE ratios) ahead of a recession, while the bars in black show it usually takes a lot longer for corporate earnings to bottom.

The one exception shown is the adjustment post-Nasdaq meltdown that had a lot longer to run because of the unprecedented exuberance that preceded it.

So… are share prices now correctly looking forward and beyond the downturn in corporate margins and profits?

Depends on what follows next. How much weakness is yet to show up in corporate profits?

My guess is it will require central bankers to stop tightening, at the very least, before equity markets can comfortably initiate the next sustainable bull market.

In the meantime, large gaps will open up between those companies with positive momentum, and those who prove themselves as relatively resilient, and those that have neither momentum nor resilience.

That process is starting in February.

February Results Thus Far

In line with my suggestion in Weekly Insights last week (see further below), investors are difficult to please thus far in this February reporting season. The onus is on companies to provide plenty of positive newsflow so that share prices can continue the upward momentum, or else.

In most cases, the 'or else' prevails; most share prices weaken on the day of financial results releases.

But the season is still young and Monday is showing enough evidence to the contrary to keep optimism alive with all of Audinate Group ((AD8)), Carsales ((CAR)), Endeavour Group ((EDV)), and even Insurance Australia Group ((IAG)) enjoying a positive response post market update.

There is no such relief for Aurizon Holdings ((AZJ)) and Lendlease ((LLC)) with both sinking in excess of -6% despite the fact both share prices are trading near lows from the past decade.

The obvious observation to make here is that a very bad past experience provides no guarantee the future will be a lot better.

Both Aurizon and Lendlease have, on balance, been subjected to downward pressures for a long while. Both on occasion receive favourable commentary from your typical value-investor, but have proven more of a value-trap than a bargain opportunity for investors.

Both pay dividends to offer at least some offset.

In contrast, Carsales is trading near its highest price post all-time record high achieved in 2021, proving yet again that a quality business doesn't lose its lustre overnight. But let's not fool ourselves, being of High Quality does not guarantee a positive response on market update, in particular not this time around.

REA Group ((REA)) is widely regarded as one of the highest quality businesses listed on the ASX. Its half-yearly update on Friday has been generally well-received by analysts, but the share price is now falling for the second day in a row.

The challenge for investors this month will be to distinguish short-term from longer-term, and to understand there's also still a macro influence that very much remains in play.

Equally telling: on Monday, the FNArena Corporate Results Monitor stats show 8 misses against 7 beats as far as the first 28 corporate updates are concerned. This is not what is required to keep this market in a positive mood.

Not making things any rosier: two of the 8 beats were delivered by REITs, while two other beats -ResMed ((RMD)) and Nick Scali ((NCK))- encountered significant share price decline.

Admittedly, it's early in the season, still. We should have a much better picture by Friday. Even by then, there remain more company releases scheduled for the following week than during the first half of the month.

Welcome to the Australian way!

(Apparently a lack of sufficient accountants is to blame, not necessarily the companies or the ASX).

Here's what Ord Minnett, through Malcolm Wood, head of asset allocation, communicated to its clientele on Friday:

"The ASX200 has front-loaded returns, limiting nearterm upside: The rally has lifted the Forward PE 2.5pts to ~15x. Earnings are stretched, 30% above pre-COVID levels. The soft landing has largely been discounted. The US is highly risky, at an elevated ~18.5x PE, despite rate and earnings risks.

"We are increasingly cautious and trim our Australia overweight. We await a US correction and signs that the RBA can pivot to rate cuts to turn bullish again."

FNArena Corporate Results Monitor

For daily updates on corporate results: https://www.fnarena.com/index.php/reporting_season/

Corporate Australia Showing Resilience

Early indications are corporate margins are holding up, with no cliff apparent to pull corporate profits into a deep trough, suggests MST Access senior analyst, Hasan Tevfik.

This is good news as Tefvik is one among many who believes Australia remains well-positioned relative to most foreign economies. This should translate into a relatively more resilient performance from corporate Australia.

Thus far, resilience in profit forecasts has largely relied on the banks and commodity producers, though Credit Suisse has observed healthcare companies have become positive contributors as well recently.

Tevfik is worried commodity producers are operating on peak margins, but so far there are no signals for a pending downturn with commodity prices staying in the higher-for-longer lane, compensating for the higher costs that are impacting on those businesses.

Biggest positive surprises thus far have been delivered by Boral ((BLD)) and Macquarie Group ((MQG)), on Tevfik's assessment, while the biggest disappointers to date have been Insurance Australia Group and Healius ((HLS)).

Note IAG's share price responded well to the insurer's financial result, but a heavy profit downgrade had been announced earlier.

Though it's early days yet, one of the positives that might come from this results season are ongoing surprises through dividends. This is, sort of, tradition in Australia, especially during tougher times.

Tevfik observes bottom-up dividend forecasts have increased by 8%. Of the $100bn that will be announced by ASX200 companies this season, nearly $40bn will come from commodity producers.

Having said all of this, reductions in dividend payouts have been much greater than expected from IAG, Healius and Boral. Amcor ((AMC)) boosted its share buyback by US$100m to US$500m.

Market strategists at Wilsons share Tevfik's concerns about upcoming headwinds for commodity producers, specifically iron ore, while Wilsons is less sanguine about the outlook for banks.

UBS points out higher-for-longer, in terms of bond yields, and more rate hikes from the RBA imply the odds for a 'hard landing' locally are shortening (i.e. more likely to happen).

Commodities –  Lithium & Dividends

One of the market segments that will be closely followed given forecasts for an extended runway for growth are ASX-listed producers and explorers that make up the local lithium sector.

Interestingly, Macquarie analysts have forecasts that in almost every case sit below market consensus, indicating there might be plenty of room for below-expectation results.

But Macquarie holds an overall positive view on the sector and retains preferences for Mineral Resources ((MIN)) and Pilbara Minerals ((PLS)) among producers, and for Patriot Battery Metals ((PMT)) and Global Lithium Resources ((GL1)) among explorers.

Peers at Goldman Sachs currently only rate one of local lithium companies a Buy -Allkem ((AKE))- with all others rated Neutral and one Sell reserved for Core Lithium ((CXO)).

Macquarie is currently positioned above consensus for mineral sands producer Iluka Resources ((ILU)), for which the broker also holds a positive view. Macquarie also remains supportive of producers of bulk commodities iron ore and coal – predominantly because prices remain higher for longer.

The metals desk at Goldman Sachs spells out what is already apparent from consensus forecasts: the current season will be the last hurrah for the commodities sector as far as dividends are concerned. Goldman Sachs maintains dividends are to remain an attractive feature for the sector in Australia, just not at the level seen in recent years.

This broker sees February as the start of reduced payouts as the major diversifieds will shift towards growth and decarbonisation capex, as well as acquisitions. Capex forecasts are likely too low, the broker argues, because of cost inflation. Goldman Sachs suspects BHP Group ((BHP)) might disappoint with its dividend, while capex is likely to surprise on the upside (a negative).

Negative capex indications might also come from BlueScope Steel ((BSL)), Mineral Resources and Alumina Ltd ((AWC)), the broker suggests. Goldman Sachs is positioned for positive surprises from Iluka Resources and Coronado Global Resources ((CRN)) and potential disappointment from Alumina Ltd.

Morgan Stanley is cautious regarding oil & gas companies with plenty of operational headwinds presenting themselves through supply chain constraints, supply cost inflation, and secondary permitting complications. Feedback from investors, apparently, is a preference for free cash flow over growth project risk.

Morgan Stanley suggests investors focus on leverage to Asia gas, free cash flow yields, and capital management initiatives.

Consumer & Gaming Stocks

Sector analysts covering consumer-related companies and the gaming sector are a lot more concerned about the downturn in spending that may yet be ahead.

Morgan Stanley has advised its clientele to be cautious and remain selective in which stocks to own. Though many stocks have underperformed noticeably year-to-date, several indications are pointing towards ongoing slowing momentum, the analysts warn.

Morgan Stanley has Overweight calls on IDP Education ((IEL)), Treasury Wine Estates ((TWE)), The Lottery Corp ((TLC)) and Premier Investments ((PMV)) and Underweight calls on both Coles Group ((COL)) and Woolworths Group ((WOW)), as well as Endeavour Group ((EDV)) and Harvey Norman ((HVN)).

An equally cautious and apprehensive Jarden has stuck with an Overweight rating for Adairs ((ADH)), inspired by a 'cheap' looking valuation.

Returning to the gaming sector specifically, Goldman Sachs is anticipating strong performances from lotteries and casinos, with higher competitive pressures in wagering. A weak result is expected from Tabcorp Holdings ((TAH)) while Sky City Entertainment ((SKC)) is nominated as a candidate for positive surprise.

Contrary to the generally positive views on The Lottery Corp, Goldman Sachs rates the stock a Sell with $3.70 price target. Ord Minnett recently downgraded the stock as a result to switching to whitelabeling Morningstar research.

Advertising & Media

Plenty of uncertainty presents itself for those traditional media companies reliant on advertisement income.

Goldman Sachs is nevertheless anticipating resilience and valuation support for most, with a preference for Nine Entertainment ((NEC)) and oOh!media ((OML)).

The broker also reminds investors companies are still executing on buybacks with less than 4% purchased of 10% buyback programs.

Insurers

Credit Suisse has identified upside risk for Medibank Private ((MPL)), nib Holdings ((NHF)) and Steadfast Group ((SDF)) and downside risk for QBE Insurance ((QBE)).

The latter is also expected to disappoint with its dividend due to "capital strain".

See also:

–https://www.fnarena.com/index.php/2023/02/08/rudis-view-guide-to-february-results-season/

–https://www.fnarena.com/index.php/2023/02/01/rudis-view-2023-will-be-different/

Plus Conviction Calls and Best Ideas:

–https://www.fnarena.com/index.php/2023/02/10/rudis-view-aub-group-endeavour-lottery-corp-suncorp/

–https://www.fnarena.com/index.php/2023/02/03/rudis-view-csl-mineral-resources-ridley-readytech/

Corporate Results Monitor

As indicated earlier, FNArena's Corporate Results Monitor is now updating daily: https://www.fnarena.com/index.php/reporting_season/

(including calendar)

Research To Download

Edison research:

-Actinogen Medical ((ACW)): https://www.fnarena.com/index.php/download-article/?n=3EDCB239-EA43-5317-34E57F9F9E92E5D0

-AFT Pharmaceuticals ((AFP)): https://www.fnarena.com/index.php/download-article/?n=3EF00E80-B89D-9F0E-EA09BDA5C0EF07FC

-Bluebet Holdings ((BBT)): https://www.fnarena.com/index.php/download-article/?n=3EF9D18A-C478-BDF1-EC8B7A652B2B2B14

-Lithium Power International ((LPI)): https://www.fnarena.com/index.php/download-article/?n=3F01E25F-FFFF-F66B-6111EEC073B37E76

-Paradigm Biopharmaceuticals ((PAR)): https://www.fnarena.com/index.php/download-article/?n=3F09D24F-D860-CAB7-76A14665660744A8

-Respiri ((RSH)): https://www.fnarena.com/index.php/download-article/?n=3F1E5BAE-C81B-8234-A77291D1DF1F63A9

-Sensen Networks ((SNS)): https://www.fnarena.com/index.php/download-article/?n=3F24806C-A70A-41EE-8BDE5BD4B8A72E46

-Vection Technologies ((VR1)): https://www.fnarena.com/index.php/download-article/?n=3F66A17A-FD2E-AC8A-0F93994E2B08F05B

Research as a Service (RaaS):

-Betmakers Technology ((BET)): https://www.fnarena.com/index.php/download-article/?n=3F8FB01F-AA84-869F-BBB9D77CE6816E62

-Harvest Technology Group ((HTG)): https://www.fnarena.com/index.php/download-article/?n=3F9A61A3-E977-2700-951A5DF4F93A9719

-Pureprofile ((PPL)): https://www.fnarena.com/index.php/download-article/?n=3FA0371C-BDEB-ABA0-AC253752A4501A96

-Rent.com.au ((RNT)): https://www.fnarena.com/index.php/download-article/?n=3FA0371C-BDEB-ABA0-AC253752A4501A96

-X2M Connect ((X2M)): https://www.fnarena.com/index.php/download-article/?n=3FAC1130-B984-25CE-0D23DA34C96F2C6B

(This story was written on Monday, 13th February, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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