FY11 Reporting Season: The Winners And Losers

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This story was first published two days ago in the form of an email sent to registered FNArena readers.

By Rudi Filapek-Vandyck, Editor FNArena

Each reporting season has its own characteristics and peculiarities, and no matter how hard we try to prepare and to anticipate, there's always room for a big surprise. This year's FY11 reporting season in Australia certainly has not disappointed on any of these accounts.

Let's start with some general observations. There have been many more earnings misses than beats. That's an understatement. According to data from Bloomberg more than 50% of all companies reporting in August missed market expectations.

This is in itself nothing unusual, all reporting seasons in Australia post 2007 have seen more companies miss expectations then beating them, though seldom by such a wide gap.

Since share prices already had been pared back, a lot, and since we were already expecting a wave of cuts and downgrades, it actually didn't seem too bad. Certainly this perception is further supported by the fact that, in a general sense, most earnings misses were quite benign and stock analysts have responded with rather mild cuts and downgrades.

Sure, we had a few really negative experiences, such as with Billabong ((BBG)), Guns ((GNS)), Goodman Fielder ((GFF)), Alesco ((ALS)) and Transfield Services ((TSE)). For all of these companies, the reverberations of this month's disappointment will weigh on the share price for months into the future, if not longer.

But there were, against expectations, many positive surprises. Such as the fact that many companies had cash in surplus and thus decided to reinstate or raise dividends, add special distributions or launch a share buy-back program. From Perpetual ((PPT)) to Crown ((CWN)), to Foster's ((FGL)), Amcor ((AMC)), CSL ((CSL)), Pacific Brands ((PGB)), Mount Gibson ((MGX)) and many others, investors were pampered with oft unexpected capital management initiatives, propping up returns at a time when the share market was flirting with two year lows.

Others, such as Rio Tinto ((RIO)) decided to buy out minority shareholders in Coal and Allied ((CNA)). BHP Billiton ((BHP)) disappointed by not announcing anything special, but the company did raise its dividend.

Overall, share buy backs and dividends have been the real surprise this reporting season. This, stockbrokers say, bodes well for the Australian share market as these initiatives put firm support under share prices.

As mentioned earlier, in the wake of this month's corporate releases, earnings forecasts by analysts have held up surprisingly well. This not only suggests expectations prior to August had become too negative, but also that earnings growth for the years ahead is not as dire as one might have feared.

So… we're back into double digit earnings growth then?

With economic growth in both the US and Europe looking shaky, China holding its own but still slowing down and with a sudden, sharp deterioration in the June quarter in Australia, it's probably wise to retain some degree of caution. Which is why some observers question whether analysts have gone far enough, or whether we will see continued cuts and downgrades in the weeks and months ahead.

One observation stands regardless and that is that the weaker parts of the Australian economy are operating under circumstances that are akin to a prolonged recession. It would also appear these companies have now finally decided to bite the bullet. I cannot recollect a similar reporting season that saw so many jobs cuts as this month with companies including Qantas, BlueScope, OneSteel and Westpac announcing up to more than 1000 jobs cuts each.

Don't forget, in the background of these headline grabbers, analysts at BA-Merrill Lynch counted more than 7000 individual job cuts since early June. One of the key questions for the Australian economy, and for the share market, is now how these thousands of job losses will impact on labour stats, and thus on the RBA's policy considerations.

All this means some overdue decisions have finally been made. Tabcorp ((TAH)) split its operations, as did Foster's ((FGL)) and Brambles ((BXB)) has put Recall up for sale, while Fairfax ((FXJ)) is going to brush a big broom through the AFR.com website and list one third of Trade Me. Ten Network is restructuring too, as is APN News & Media ((APN)).

All in all, or so it would appear, "recession" is now day-to-day reality for retailers, manufacturers, property markets, media companies and for tourism operators, but for most companies in other sectors life ain't so bad. Mind you, this has been the reporting season in which rising costs and a strong AUD started biting for miners and energy companies and most have disappointed with their results (as in: they missed market expectations).

The stand-out observation, for me, was that BHP Billiton achieved its record annual profit (+72% or something similar) on a 4% increase in volume. Let's face it: copper, iron ore and crude oil prices are not going to double in price in the year ahead (at least, let's hope not) so investing in mining and energy companies will be all about meeting production targets and achieving production increases from here onwards.

In case anyone wondered: BHP's EPS growth is now projected in mid-teens percentage for this year and with little left for FY13. The Great Australian has a lot of cash in surplus to prop up these numbers, a lot of smaller peers do not.

History suggests companies that raise their dividends are more likely to outperform in the months after reporting season, while those that cut dividends usually underperform, but I remain skeptical whether this also applies to BHP Billiton and other resources companies. Mining companies have equally surprised with their dividends this reporting season, but that still won't change their volatile character and close links to global growth and general risk appetite.

Probably the biggest surprise this reporting season is that when it comes to genuine profit surprises, those that force analysts to lift projections and maybe even raise valuations, targets and recommendations, the main source for such surprises has been industrials.

Number one in the queue are the so-called pick and shovel services providers to the energy and mining sectors, with companies such as Bradken ((BKN)), RCR Tomlinson ((RCR)), Mineral Resource ((MIN)), Forge Group ((FGE)) and Campbell Brothers ((CPB)) all producing genuine surprises with upside potential for the years ahead.

This group of companies produced many more positive results, including from Fleetwood ((FWD)), GR Engineering ((GNG)), and Boart Longyear ((BLY)), but the five mentioned are simply the true stand-outs as far as positive changes to analysts estimates and targets are concerned.

Surprises also came from Domino's Pizza ((DMP)), ARB Group ((ARP)), Envestra ((ENV)) and Lycopodium ((LYL)) but investors should be extra cautious with regards to these four as valuation limits seem to have already presented themselves.

Stocks that equally surprised, but with still plenty of valuation potential left, include (in no particular order) Sims Group ((SGM)), Austbrokers ((AUB)), Iluka ((ILU)), Macquarie Telecom ((MAQ)), Amcor ((AMC)), Challenger Financial ((CGF)), NIB Holdings ((NHF)), Super Retail Group ((SUL)), Santos ((STO)), Tox Free Solutions ((TOX)), Wesfarmers ((WES)), SAI Global ((SAI)), CFS Retail Trust ((CFX)), Carsales.com ((CRZ)), Flexigroup ((FXL)), Kathmandu ((KMD)) and… Telstra ((TLS)).

Each reporting season delivers its own key sentiment reversals that have long lasting consequences. For example, in February this year Ardent Leisure ((AAD)) rose from the dead, while the tide turned against CSL ((CSL)) and CSG Group ((CSV)). Today, share prices for both CSL and CSV are well below levels from earlier this calendar year.

In the same vein, I believe the current reporting season is likely to have brought key reversal in underlying sentiment towards Telstra, in a positive sense, and negative reversals for Matrix Composites & Engineering ((MCE)), QBE Insurance ((QBE)) and for Woolworths ((WOW)).

The latter is even more emphasised by the fact that main competitor Wesfarmers is among the genuine stand-out performers this month, while the traditional third dog in the sector, Metcash ((MTS)) delivered a truly remarkable stunt in court in the face of ACCC unwillingness to allow for the Franklins acquisition.

I suspect Woolworths shares are now in the process of being de-rated, which probably makes it a $25-something stock for the near term, instead of a $27 stock with upside potential to $30.

(All of the above omits the final three days of the August reporting season, which translates roughly into 95% of market cap in Australia and some 85% of all major companies listed).

This story was written on Monday, 29th August 2011. It was published on the day in the form of an email to paying subscribers.

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