AGM Minefields?

This story features STOCKLAND, and other companies. For more info SHARE ANALYSIS: SGP

By Rudi Filapek-Vandyck, Editor FNArena

Investor sentiment may have spiked up in recent weeks, but there's still plenty around to be less than excited about. How about a less than forthcoming euro summit over the weekend? Or more disappointing earnings reports in the US?

On the other hand, the early release of the Mid-Year Economic and Fiscal Outlook (MYEFO) by the Australian Government on Monday has further strengthened general expectations that more interest rate cuts from the RBA should remain on the agenda.

As Wayne Swan and Co stick to their promise of a budget surplus next year that can only mean one thing: net negative government spending in a weakening economy. Lower interest rates look like the logical offset.

It is possible that the prospect for more interest rate cuts will keep the Australian share market supported in the months ahead. And if the re-balancing of the economy occurs as planned by the RBA, then many of the beaten down industrial stocks should witness a revival on the back of better earnings growth prospects in FY14 and further into the future.

One of the problems with this scenario remains, however, that many companies in Australia are right now still battling tough circumstances and this has the potential to bring out more bad news and disappointments first. All eyes on the local season for Annual General Shareholders Meetings thus. What's it going to be this time? More bad news or will boards decide to keep their expectations internal until after the Christmas break?

There's probably no need to sound any alarm bells, but investors might want to stay on high alert after some truly nasty surprises recently. Last week, a market update by property bellwether Stockland ((SGP)) forced analysts to -again- cut estimates which in return has triggered renewed selling pressure for the shares. The same happened to drilling services provider Imdex ((IMD)). And who can forget the disappointing market updates by Bank of Queensland ((BOQ)) and National Australia Bank ((NAB))?

On Monday, the board of Ansell ((ANN)) acknowledged there was some pressure on sales in Europe, but no reason to revise its guidance for the year. The share price still came under selling pressure.

Quantitative analysts at Macquarie recently updated their analysis on Australia's AGM season with historical data suggesting companies that disappoint their shareholders can look forward to a decline in the share price of some 4.5% in the following 40 days post the announcement (Macquarie's calculated "median return"). However, say the analysts, given that share prices have appreciated by double digits in the lead-up, there's every chance this year's punishment might come with bigger numbers.

As per usual, it may well be a case of the stronger are still strong (and thus offer less chance for serious disappointment) while the weaker remain weak which automatically offers shorter odds for more disappointment. Certainly recent examples of Stockland and Bank of Queensland support this thesis. But shares in Ansell, one of those stand-out All-Weather Outperformers ^(*) in the post-2007 era, recently surged to an all-time record high of $16.63. This in itself makes investors edgy for what can possibly come next and post the admission of a slow down in European sales in the current half-year investors have taken off some of the gloss from the share price.

Many of this year's outperformers continue performing strongly (including Ansell, by the way) and investors need to look no further than retail conglomerate Super Retail Group ((SUL)) whose update for continued growth in all three divisions triggered yet another mini-rally (up more than 3% on the day) in the share price. Super Retail Shares have risen by nearly 70% since the start of the calendar year. At the current share price they're still paying a 4.2% fully franked dividend on top.

If we are expecting more disappointments then surely bricks-and-mortar retailers (but not Super Retail), property developers (see Stockland) and traditional media companies are the most obvious sectors to steer away from? A recent report published by JP Morgan suggests the latter group of companies remains an open minefield in Australia. JP Morgan's opening sentence in the report really says it all: "We believe the upcoming Media AGM season (Oct/Nov) will see consensus downgrades across the traditional media names".

Ten Network ((TEN)), which was specifically highlighted in the report, already delivered its bad news announcement regarding no sale for subsidiary EyeCorp. Stockbrokers are warning of the need for a potential capital raising, despite Ten Network denying this will be necessary. Expect more of the same from the likes of Fairfax Media ((FXJ)), Southern Cross Media ((SXL)) and Seven West Media ((SWM)) seems to be the message from JP Morgan. Note that most stockbrokers have been lowering estimates recently on lower than expected advertisement spending this half and -again- on the follow-through effect from the Ten Network update.

Incidentally, JP Morgan doesn't like online media company Seek ((SEK)) either on suspicion that the upcoming AGM might bring out some disappointing announcements, but this is certainly not a widely carried view as colleagues at other stockbrokerages have been highlighting Seek to possibly deliver investors with a positive surprise. All shall be revealed on November 29th when board and shareholders are scheduled to meet.

Another sector that will be high on investors' radar for possible landmines are services providers to miners and the oil and gas sector, but not everyone is equally convinced about this. The likes of Citi have been very cautious towards the sector since Q2 this year, drawing from international feedback and overseas sector surveys to further lower earnings estimates prior to upcoming market updates. Macquarie, however, published a sector AGM update on Friday suggesting if anything the sector is likely to largely re-iterate previous guidances for FY13, which may well be received positively since most share prices have been hammered in recent months.

Macquarie analysts do suggest a troubled UGL ((UGL)) may have more disappointment in store with the analysts speculating net profit growth in the first half might turn out negative on annual comparison and that might still spook part of the investment community. For the likes of Monadelphous ((MND)), which is still trading at a relative premium to the sector on the basis of a superior track record and more visibility in revenues, Macquarie suggests that any change in tone (for the worse) might be received as a signal of weakness. Investors are used to receiving positive surprises from Monadelphous and back in August company management highlighted the strong construction visibility for the next two years based on energy and resources projects in the execution phase. Has anything changed since? All shall be revealed on 20th November.

Macquarie also believes the board at WorleyParsons ((WOR)) will likely report ongoing strong operational momentum while re-iterating guidance for good growth. Transfield Services ((TSE)) and Downer EDI ((DOW)) are also expected to issue positive statements. In the case of Transfield, I am sure many an investor will agree with me if I respond with: that would be about time!

After cutting estimates across the sector, Citi analysts recently reiterated their preference for "undervalued" Downer EDI.

Analysts at Morgan Stanley recentlty singled out Super Retail Group for a positive AGM update among "Emerging" companies in Australia. That view has now been vindicated. Morgan Stanley has labelled Super Retail "top consumer pick" but runner up, The Reject Shop ((TRS)), equally enjoys positive anticipation. Some analysts are suggesting online travel services retailer Wotif.com ((WTF)) appears due for a profit warning, but Morgan Stanley analysts are as yet not convinced. They do believe peer Flight Centre ((FLT)) is once again positioned for a positive surprise, as are Fantastic Furniture ((FAN)) and Automotive Holdings ((AHE)) while for perennial outperformer Domino's Pizza ((DMP)) the task for growing at double digits is getting harder. Regardless, Morgan Stanley does not anticipate disappointment at this year's AGM.

BA-Merrill Lynch is most worried about the lack of earnings growth in general in Australia. With share prices continuing to rise, the Day of Reckoning draws ever so closer in the view of BA-ML strategists. They have singled out Australian banks for disappointment and thus far both Bank of Queensland and National Australia Bank have vindicated that view. With resources stocks suffering most from downgrades in months past, BA-ML now believes industrials stocks are the sector to watch out for. Selected stocks likely to disappoint include Seek, Asciano ((AIO)), QR National ((QRN)), Toll Holdings ((TOL)), JB Hi-Fi ((JBH)), Harvey Norman ((HVN)), Wesfarmers ((WES)) and Telstra ((TLS)).

BA-ML strategists are of the view that downgrades to Australia's profit forecasts will continue and the AGM season is seen as "potentially a near-term catalyst for further reassessment by analysts".

Macquarie strategists, who are equally cautious towards prospects for corporate profits in Australia for the 6-12 months ahead, do not think investors should be overly worried. But then again, the strategists also believe AGMs will not provide the necessary upgrades to justify rising share prices.

Amongst the potential candidates for a positive surprise selected by Macquarie we find Arrium ((ARI)), Crown ((CWN)) and Beach Energy ((BPT)) while Seek, on Macquarie's assessment, might well surprise by not announcing anything negative. On Macquarie's "uh-oh" list we find Boral ((BLD)), Sims Group ((SGM)) and Seven West Media.

Lastly, analysts at JP Morgan have taken an interest in Australia's two-strike rule with regards to board remunerations. While the analysts do not anticipate any of the Top 100 companies will suffer embarrassing defeat as a result of the rule, their analysis has shown that companies receiving the embarrassment of the first strike on average see their share price underperforming in the first month following the AGM.

To recap, the legislated two-strike rule in Australia prescribes that where 25% or more of eligible votes are cast against the remuneration report for the second time, a resolution to vote for a meeting to spill the Board must be called. The resolution is carried with a 50% majority cast in favour of a spill. The “spill meeting” must then be held within 90 days. Those directors (excluding the MD) who were board members at the time of the remuneration report must stand down prior to the Spill meeting before they can be reconsidered for re-election.

Companies that received a first strike last year include Crown, Dexus Property ((DXS)), UGL and Bluescope Steel ((BSL)).

(This story was originally written on Monday, 22 October 2012. It was published on that day in the form of an email to paying subscribers.)

Good news for FNArena subscribers: colleague Greg Peel has just finished an in-depth market update on rare earths elements (REE) which will soon be published in e-booklet format, for FNArena subscribers only.

P.S. All subscribers have 24/7 access to the FNArena calendar which is updated continuously, including for AGMs.

^(*) All-Weather Performers have featured prominently in my market commentaries post 2007. Last year I published an e-booklet titled "The Big De-Rating" (available to all paid subscribers) in which the concept of All-Weather performers is explained. I will soon be writing my follow-up on All-Weather Performers which will also be made available to all paying subscribers in e-booklet format.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)

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