Rudi’s View: February’s Sobering Reality Check

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In This week's Weekly Insights:

-February's Sobering Reality Check
-Research To Download

By Rudi Filapek-Vandyck, Editor FNArena

February's Sobering Reality Check

Australian businesses are doing it tough. Maybe the easiest way to back up that statement is via FNArena's Corporate Results Monitor.

By late on Friday, the Monitor had aggregated 241 corporate results of which 31.5% (76 results) had managed to beat expectations and 29.5% (71 results) had failed, with the remaining 39% (94) performing in line.

Price targets on average had increased by 0.23% but in aggregate 241 price targets in total have not moved at all (-0.03%).

Share price-wise, most reports have triggered selling pressure and the major indices are down more than -3.5% for the month on Monday. All it takes from here is one or two negative trading sessions and those sharp gains booked in January will be gone.

If we zoom in on the ASX50, of which a total of 41 members have reported, the numbers look decisively more encouraging; 41.5% (17 companies) have beaten market forecasts and only 26.8% (11 companies) missed the mark. On average, price targets have lifted by 1% with an aggregate increase of 0.93%.

Comparable numbers for the ASX200 look a lot worse. Of the 137 companies reporting to date, which includes the 41 from the ASX50, only 30% (41 companies) released a 'beat' with 33.5% (46 companies) disappointing. While the average price target for the ASX200 has increased by 0.31%, in aggregate targets have gone backwards by -0.21%.

To create a proper framework around those numbers, we first have to acknowledge the trend since 2013 is that February usually allows for a larger percentage of 'beats' in comparison with August. For example: the two previous February result seasons of 2022 and 2021 saw total 'beats' of respectively 43% and 47%.

If that 31.5% of beats this month holds up when the final calculations are made later this week, it will be near the lowest percentage for any February on par with 2020 and 2014 (31%). Both those years were challenging times for the local share market.

Disappointments running at 29.5% is not out of the ordinary. Last year, the percentage was 36%, the year prior only had 13%. This year the percentage in misses is high, though not extraordinary.

What has stopped is that results seasons add meaningfully to corporate valuations and thus to broker price targets, as also signalled last week. Ever since we left calendar year 2021 behind us, corporate results seasons are no longer providing a positive outcome for price targets for individual ASX-listed entities.

Yet, at the beginning of this month, major indices were but a whisker away from setting new all-time record highs. Go figure. Maybe, if we take those 2023 highs as our starting point, maybe then the February results season has provided investors with a reality check?

Like a cold shower on a hot and sweaty mid-summer day?

Aussie Battlers Showing Resilience

Uninspiring and underwhelming, but February 2023 hasn't been an entirely negative exercise for Australian investors.

Plenty of corporate releases are showcasing resilience, growth, bonus dividends, share buybacks and fresh acquisitions, even if in some cases this was combined with the inability to meet or beat analyst forecasts.

As the Monitor data indicate, the good news and the resilience are mostly coming from the big end of the market.

The latter shouldn't surprise as the difference came often down to the degree of pricing power and cost growth containment; two factors more often found among larger-sized companies.

Analysts at Martin Currie identified three other key factors this month: leverage to rising interest rates, ongoing tailwinds from societies re-opening post covid lockdowns, and resilient (but softening) spending by consumers and businesses.

Positive stories that come to mind this month are insurers and their brokers for the positive interest rate correlation, QBE Insurance ((QBE)) and Suncorp Group ((SUN)) in particular, but also AUB Group ((AUB)), Steadfast Group ((SDF)) and PSC Insurance ((PSI)) as the insurance brokers.

Areas of strength thus far have shown up through travel and resources sector contracting, though I would most definitely include many of the High Quality sector leaders on the ASX who, it has to be pointed out, only rarely disappoint fundamentally. This season many of those companies exhibited resilience, quality and growth where many others were unable to.

Regular readers know the companies I am referring to: the list includes Goodman Group ((GMG)), REA Group ((REA)) and Macquarie Group ((MQG)), as well as Pro Medicus ((PME)), HUB24 ((HUB)), Ebos Group ((EBO)), Carsales ((CAR)), Seek ((SEK)), Woolworths ((WOW)) and CSL ((CSL)), among others.

Analysts at Morgan Stanley, who keep a close tab on performances by High Quality and Low Quality companies report the pendulum this month has decisively swung in favour of the former, i.e. High Quality is outperforming the local trash.

Having been an avid market watcher for more than two decades, I can confirm High Quality stalwarts mostly perform well during most seasons. There might be a message in here for conservative investors with a longer term horizon.

For ongoing tailwinds from re-opening borders, there's probably no better example than Qantas Airways ((QAN)), while many a discretionary retailer has proved the doubters wrong this month. Discretionary retailers, alongside the automotive sector, stand out through resilience in February. Yet, UBS probably summed it up best as far as most investors' focus is concerned:

"the economy companies were in is not the one they are entering".

Underneath the daily share price moves and the headline numbers, UBS strategist Richard Schellbach and associate analyst Sparsh Polepalle spot "waning" earnings momentum with the local analyst community gradually coming to the conclusion that operational momentum for corporate Australia has already peaked.

What lays ahead are more and tougher challenges as economies slow and central bankers are still hiking interest rates.

On UBS's assessment, companies most worried about a possible hard landing for the Australian economy later this year are mostly operating in the building materials sector, in steel and in traditional media. Early signals of consumers changing their spending habits came from big ticket retailers, but also from supermarkets and food producers.

Sectors already doing it tough, judging from this month's market updates, include food producers, builders and real estate companies.

No More Mr Nice Guy

A different thesis has been put forward by analysts at Morgan Stanley who, after observing how share prices in companies that disappoint are often receiving a harsher-than-usual punishment, conclude the end is here of the "era of forbearance".

Investors are no longer prepared to give companies the benefit of the doubt, says Morgan Stanley. Patience is waning. Punishment is becoming the response du jour in case expectations are not being met.

Anecdotal examples support this thesis. On Friday, Mineral Resources ((MIN)) released what appeared a half-yearly set of numbers that fell short of analysts' projections, but the share price recovered quickly during the day. On Monday, however, the shares are down in excess of -6% as I write these sentences.

Earlier in the season, dividend disappointment from BHP Group ((BHP)) elicited a similar quick recovery in the share price, but BHP shares are now well below the $50 at which they started off at the beginning of the month. By the way: I am by no means suggesting these moves are 100% free of macro-economic affect.

Best performing sectors this month, on Morgan Stanley's analysis: insurance, staples and healthcare. Average punishment for results that miss expectations thus far this month has been a retreat in the share price of -3.9% – this is the largest sell-down on the broker's data since the -5.2% recorded for August 2016.

Equally interesting, the same data also show this month's reward for companies that beat forecasts has been below average with share prices only adding on average 2.2% on the day of result release. In most seasons, the data show, rewards tend to be higher than the average punishment.

Not this month.

Share prices from companies that downgraded guidance have been punished with an average sell-down of close to -10%, report the analysts, while companies that upgraded guidance have only seen their share prices lift by 2%-plus on average. Those who maintained guidance have on average seen a slightly negative response.

In equal fashion, extreme negative responses have been larger than positive rewards. Morgan Stanley lines up Red 5 ((RED)), Temple & Webster ((TPW)), Aurelia Metals ((AMI)), Domino's Pizza ((DMP)), St Barbara ((SBM)), Lake Resources ((LKE)), Jervois Global ((JRV)), Star Entertainment ((SGR)), Westgold Resources ((WGX)) and Adairs ((ADH)) whose share prices lost between -36% and -20% in February while on the positive side only two share prices gained more than 20%; Arafura Rare Earths ((ARU)) and GUD Holdings ((GUD)).

The large number of negative results ('misses") is seen as an obvious stand-out this month with only result seasons in 2019 and 2020 showing similar numbers – those were tough times for Australian businesses, probably best remembered through the fact that back then energy companies and the banks cut their dividends pre-covid epidemic.

Factors most cited by company officials to describe the challenges facing their business are cost pressures/inflation, higher interest rates and ongoing labour shortages, as also shown on the graphic below by Martin Currie. Gone are the many references to supply-chain pressures and the energy crisis that dominated in previous seasons.

Government intervention is a new negative threat that featured this month.

Cuts: Scissors Versus Chainsaws

Cuts to earnings forecasts are dominating analyst activity in February. Only two sectors have seen estimates rise: consumer staples and financials with the added remark that forecasts for banks are falling, it's the insurance companies that are providing positive offset.

Those who happen to read the Australian Financial Review (AFR) already know market updates this month coincide with early on-the-ground indications the banking sector is preparing for savage, margin-reducing competition for the wall of fixed-interest mortgages that is about to expire, looking for refinancing in the months ahead.

Bank share prices have been a major drag for the local market this month.

Sectors suffering the heaviest downgrades to forecasts are energy, materials (i.e. miners) and communication services. This applies for both FY23 and FY24 forecasts.

Assuming no further cuts, which is probably optimistic, the ASX200 is forecast to grow average EPS by circa 4% in FY23. The numbers for FY24 and FY25 are close to zero. As per usual, the dispersion behind these averages is enormous with strong growth projected for industrials, info tech and utilities and heavy deterioration for energy (in particular post the current year) and materials.

In between sit sectors like consumer discretionary, staples, healthcare, real estate and financials with steady-as-she-goes EPS growth projections.

Starting from current consensus forecasts, the valuation of the Australian share market, both as expressed through the average PE ratio and the average dividend yield, is trending around long term averages on respectively 14.5x (approx) and 4.2%.

Plenty of bonus dividends have been announced this month, which is the predictable response from Australian boards when times get tough as this is usually their idea of compensating shareholders, but investors might nevertheless pay heed to the fact there have been plenty of disappointments as well, not in the least because large cap miners can no longer keep up with the elevated payouts from the boom times in 2021 and 2022.

As shown in the graphic overview below, as per Martin Currie's research, the end outcome from the February reporting season has been positive for sales projections, but negative for profits (EPS) and also negative for dividends, albeit only in a modest fashion.

As the numbers have been updated for FNArena's Corporate Results Monitor late afternoon on Monday, the pendulum has swung back towards more disappointments; out of the updated total of 268 corporate reports, more than 30% (81 companies) have been labelled as a disappointment, while slightly less companies (80) have beaten market expectations.

The average price target has now increased by 0.10% but in aggregate targets have gained 0.43%. The difference between ASX50 companies (now 43 having reported) and the ASX200 (143 companies) remains noticeable.

Heavy share price falls on Monday for Appen ((APX)), down -15%-plus, City Chic Collective ((CCX)), down almost -12%, and Downer EDI ((DOW)), down -23%-plus, suggest this February results season continues to be one of the most brutal in recent times.

As per my observations in previous weeks: this season has been in particular brutal for investors who held on to prior disappointments in the hope of better times (finally) arriving.

No doubt, many holding on to shares in Appen, Baby Bunting ((BBN)), City Chic, EML Payments ((EML)), GWA Group ((GWA)), Pacific Smiles ((PSQ)), Pepper Money ((PPM)), Southern Cross Media ((SXL)), Temple & Webster ((TPW)) and the like had thought (hoped?) things could not genuinely get a lot worse.

Long-time strugglers such as AMP ((AMP)), Lendlease ((LLC)), Magellan Financial ((MFG)) and Platinum Asset Management ((PTM)) equally found providing relief for shareholders too big of a challenge this month, yet again.

As economic conditions are likely to only get worse from here onwards, investors might find many of the recovery-stories-in-waiting require a lot more patience in 2023.

FNArena's Corporate Results Monitor

The Monitor continues to be updated daily, but not for much longer as the season draws to its natural conclusion:

https://www.fnarena.com/index.php/reporting_season/

Paid subscribers have access to commentary and data going back to August 2013.

See also:

–https://www.fnarena.com/index.php/2023/02/22/rudis-view-ma-targets-whos-next/

–https://www.fnarena.com/index.php/2023/02/16/rudi-interviewed-tough-february/

–https://www.fnarena.com/index.php/2023/02/15/rudis-view-february-focus-on-resilience-dividends/

–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/

Research To Download

Edison Research on:

-Alkane Resources ((ALK)):

https://www.fnarena.com/index.php/download-article/?n=A1B852E5-D461-BD50-C213C1E257122308

– Respiri ((RSH)):

https://www.fnarena.com/index.php/download-article/?n=A1C106BB-DE42-EB53-A98BEA1747649DA5

Research-as-a-Service (RaaS) on:

-Connexion Telematics ((CXZ)):

https://www.fnarena.com/index.php/download-article/?n=A1DAA997-09FC-46AC-A3ED18B5E3AF5F14

-Millennium Services Group ((MIL)):

https://www.fnarena.com/index.php/download-article/?n=A1E4318D-B1C3-C5E8-545E08220E2F11E7

-Rent.com.au ((RNT)):

https://www.fnarena.com/index.php/download-article/?n=A1EEB6B1-ADD3-E86D-144841707F476674

-TCM DAF Australia:

https://www.fnarena.com/index.php/download-article/?n=A2002C2D-0671-42E6-BFA60A41A178F9CC

(This story was written on Monday, 27th 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: contact us via the direct messaging system on the website).

FNArena Subscription

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