Rudi’s View: Too Many Distractions From Corporate Results

This story features LOVISA HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: LOV

In this week's Weekly Insights:

-Too Many Distractions From Corporate Results
-All-Weather Model Portfolio

By Rudi Filapek-Vandyck, Editor FNArena

Too Many Distractions From Corporate Results

Consumer-related companies and retailers have been at the centre of the February reporting season in Australia; mostly not in a favourable manner -at least not in share price performance terms.

This turned out the ideal background for cheap-bling retailer Lovisa Holdings ((LOV)) to show not all retailers are made of the same ilk, and not all are struggling to contain costs, retain staff and re-connect with customers.

Lovisa's 59% jump in earnings throughout the six months ending in December simply pulverised analysts' forecasts with stockbroker Morgans stating the performance was "nothing short of remarkable". This, the broker continued in its response the following day, is potentially one of the biggest success stories in Australian retail.

At least that is the prospect. Lovisa obviously has found and developed a formula that is appealing to younger women who don't want, or cannot afford, expensive Bulgari or Harry Winston, and who keep revisiting its stores. Retailers like Lovisa live and die by rolling out ever more stores, and this implies adding new geographies.

Are India and China on management's radar? Market speculation says yes. The potential growth path ahead if Lovisa were to successfully enter those mega-markets… it's almost beyond imagination. It would definitely vindicate Morgans' grand enthusiasm. Premier Investments' Smiggle squared, or something similar.

In the short term, throughout the fog of war and all the extra macro-considerations that have been weighing on share prices these past few weeks, analysts have raised their forecasts, bumped up their valuations and kept their ratings overwhelmingly on Buy, or equivalent.

And investors have pushed the share price higher on every day following the interim results release.

Lovisa is not an overnight discovery. Since listing in late 2014, the share price has been in a steady up-trend, albeit with at times heavy volatility along the way, typical for retailers but also typical for a heavily polarised market that repeatedly seeks to switch momentum in favour of cheaper-priced 'value' stocks.

In case there was any doubt, Lovisa is very much a growth stock, and its dividend yield and Price-Earnings (PE) multiples are very much reflective of this. The share price is now well off the level seen before the interim result release last week, but also still well below last year's all-time record high and the consensus price target (both not too dissimilar at $23 and $22.64 respectively).

And herein lays the investor dilemma in 2022: should we take guidance from macro considerations such as bond yields, rising inflation, central banks winding back stimulus, Russia upsetting the world with tanks and bombs, and/or the prospect for slowing global growth, or should we simply stick with concentrating on solid and resilient corporate growth stories such as Lovisa?

It's a tough one, because for every Lovisa that is out there, there is a much larger number of companies that simply cannot match this. Plus it's much easier to spot the difference in hindsight.

Consumer-oriented companies needed to find a solution to supply-chain bottlenecks and they built up their inventories in response, but this has a negative impact on cash flows and margins, maybe even on profits and the market has responded with savage sell-offs.

From Accent Group ((AX1)) to Temple & Webster ((TPW)), with in between Adairs ((ADH)), Adore Beauty ((ABY)), Baby Bunting ((BBN)), City Chic Collective ((CCX)), Super Retail ((SUL)) and numerous others; all have received the harsh treatment in February.

Granted, it wasn't always simply because of the built-up inventories, and the outlook for the sector is very much aligned with consumers' willingness, and ability, to spend. Having said this, the past decade (plus some) has shown time and again it's best not to lose confidence in a well-run retailer such as JB Hi-Fi ((JBH)) – just ask the shorts that get burned every single reporting season, including this year after management pre-guided financial numbers in January.

While JB Hi-Fi shares have been extremely profitable for loyal shareholders up until mid-2020, they have effectively gone nowhere since with lots of volatility before and after, further highlighting the challenges for investors this year.

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Another stellar performer that has proved the doubters wrong this past season is platform operator Hub24 ((HUB)), having been sold down hard first after competitor Netwealth ((NWL)) released a disappointing update.

But Hub24 is not one-on-one comparable with Netwealth or any of the smaller players in the world of financial platforms, as also proven by its interim report two weeks ago.

Similar to the discretionary retailers mentioned earlier, share prices for the likes of Hub24 can be extremely volatile under adversarial circumstances. Hub24 shares reached an all-time record high of $34 in mid-October last year. Earlier this month, on Netwealth-sympathy, the shares sank to close to $22.

Even though the interim report has relegated short-term doubts into the background, the rally post-results still hasn't pushed the share price beyond the level at the start of the fresh calendar year.

Assuming the exodus in investor funds from large managed funds (such as the ex-bank funds and AMP) continues for longer, and many predict it will, platforms such as Hub24 continue to operate from a sweet spot with new funds flowing in day after day, month after month, year after year.

And after years of eating away at the shrinking customer base of the big players in the domestic market, total market share for challengers such as Hub24 and Netwealth is still small, hence why there could be so much more growth on the horizon.

The number one problem for a company like Hub24 is that it is carrying the label of 'technology'.

I would argue it is a financial, if anything, with funds under administration one of its key financial metrics, but few of those who stand ready to sell more shares whenever technology falls out of favour yet again would agree with me (the market runs on broad generalisations; details come much later in focus).

The second key problem is that share indices are below starting points for the year, and many hold negative views about the outlook for equities, in particular if high inflation stays around and bond yields need to rise higher.

The two factors have large overlap, but as long as both remain in question, I sense there will be a limit as to how high Hub24 shares can rally, irrespective of how good its financial performance turns out to be.

Note: Hub24 shares are held by the FNArena/Vested Equities All-Weather Model Portfolio.

Similar to the example of Lovisa Holdings, it would not have been easy for investors to pick the winners out of the local technology sector in February. Computershare ((CPU)) -also a 'financial' at heart- is everybody's friend when interest rates are believed to be on the rise, but otherwise it has been slim pickings in February.

The story for many of the positive performers throughout the month, including Macquarie Telecom ((MAQ)), NextDC ((NXT)), and WiseTech Global ((WTC)) to name a few, looks rather similar. Post solid results shares have bounced, but they had sold down quite heavily beforehand.

For these shares to close the gap with price targets we need to see more clarity about the prospects for inflation, bond yields and central bank tightening. War in the Ukraine might already have changed the trajectory for each, but we don't know this for certain just yet.

It likely means current shareholders might need to remain hopeful and patient for longer, while those investors looking to get on board still have plenty of time and opportunity at hand.

At the opposite end of the sector's ledger, the punishments have been almost extraordinary in case of disappointment. Granted, investors should have asked questions much earlier about Damstra Holdings ((DTC)) as this month was far from the first time management surprised on the downside or missed market expectations.

This may yet turn out another example of buying questionable acquisitions that do not turn into diamond assets once under different management.

Some odd behaviour was on display from management at Appen ((APX)) with the company no longer providing annual guidance, instead putting forward some lofty ambitions years into the future.

If finance were more commonly integrated in everyday society, this would be the subject of many jokes during stand-up comedy nights at the local pub, but alas, we'll have to stick to making jokes among investors instead.

If a company no longer provides guidance, it automatically can no longer miss that guidance at the end of the financial year.

The absence of guidance was not taken lightly for Life360 ((360)), while Megaport ((MP1)) got punished for increasing investment while there is no prospect for turning profitable soon. Fineos Corp ((FCL)) continues to suffer from IT hesitancy among insurers globally.

Analysts feel Bigtincan ((BTH)) has been unfairly treated, but my focus remains with the likes of IDP Education ((IEL)), REA Group ((REA)), and Seek ((SEK)) – all stocks of which I am convinced would be trading at higher levels today if not for macro-considerations.

In general terms, and investors should take this on board as the new gospel, post the easy momentum ride of the years past, the market will be paying close attention to cash flows and progress towards turning net cash flow positive from here onwards.

This means technology companies must show more than simply a promising marketing folder; it's now about Show Us The Money.

This is a positive development; it means the wheat will be separated from the chaff; true quality will be rewarded, while low quality on empty promises will be left to the day traders and high-risk gamblers.

It's good to know one's own preference and strategy. I am with the quality seekers. I happily leave Damstra, and Appen, and Bravura Solutions ((BVS)), and EML Payments ((EML)), and Kogan ((KGN)), and Limeade ((LME)), and Nanosonics ((NAN)), and Nearmap ((NEA)), and Nuix ((NXL)), and Reckon ((RKN)), and Redbubble ((RBL)), and Superloop ((SLC)), etc far away from my personal attention.

Not that none of these companies has any chance of becoming a success story in the future, but at this point in time the risks are too high and that lack of certainty will reveal itself.

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Among the companies that confirmed the solidity of their business and its outlook in February I would include Aussie Broadband ((ABB)), ARB Corp ((ARB)), Breville Group ((BRG)), Charter Hall ((CHC)), CSL ((CSL)), Ebos Group ((EBO)), Goodman Group ((GMG)), Pro Medicus ((PME)), ResMed ((RMD)), Seek, WiseTech Global, and Woolworths ((WOW)).

There are no cyclicals in that list, as the cycle can still turn later this year, and it's outside of control for individual companies.

Companies that are steadily building a track record of disappointment include Ainsworth Game Technology ((AGI)), Blackmores ((BKL)), Bravura Solutions, BWX Ltd ((BWX)), Crown Resorts ((CWN)), Inghams Group ((ING)), Kogan, Lendlease ((LLC)), Nuix, and Wagners ((WGN)).

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In terms of the February reporting season statistics; the numbers look absolutely fantastic – at face value.

The FNArena Corporate Results Monitor has finished the month with 342 reporting companies in its tally, of which 148 (43.3%) "beat", 125 (36.5%) met expectations and only 69 (20.2%) "missed".

This makes February 2022 the second best February season behind February last year in the history of our Monitor (going back to August 2013).

Further adding to the underlying positive picture is that EPS forecasts on average have improved throughout the month, whereas historically forecasts tend to decrease during reporting season. This time around banks and resources, large caps, have been the noticeable outperformers, with the energy sector the stand-out on a big rise in prices for crude oil and gas.

UBS strategist Richard Schellbach makes the point the media sector, both traditional and online, has proved itself as a great barometer of economic strength this season.

Supply chains, labour constraints, and otherwise rising costs turned up as most cited headwinds for companies who proved much more savvy and resilient than analysts had given them credit for in managing costs and margins.

But while all that is good news, even bordering on the fantastic, there is one negative statistic that stands out like a sore thumb, and it is a negative one:

The average price target in February has fallen by -2.27%. In aggregate, total price targets combined for the 342 companies covered fell by -1.56%. These are the worst numbers since August-2013, indicating how a change in the macro-picture (inflation, bond yields) has weighed upon stock valuations this month.

More positive news came through via dividends, with further recovery in bank dividends and ongoing strength for iron ore producers in particular pushing total dividends paid out in Australia to new highs, once again beating expectations.

A fact that hasn't been emphasised elsewhere, on my observation, is that BHP Group ((BHP)) has now become the highest dividend payer in the world, and the company paid out another record half-yearly dividend in February – go figure.

On Janus Henderson's statistics, Australian investors have absolutely no reason to complain when it comes to receiving dividends from listed companies with BHP now sitting on top of the world's ranking, while Rio Tinto ((RIO)) sits on spot number three (Microsoft sits in between on number two) and with Fortescue Metals ((FMG)) on spot number ten.

Strong mining and recovering banks pushed up total dividends to a new record high in 2021, reports Janus Henderson, to reach $87.1bn. Globally, total dividends totalled US$1.47trn, and they are projected to rise to US$1.52trn by year-end.

FNArena's Monitor will be fine tuned over the days ahead as analysts catch-up on omissions and delays during the month, but only minor changes should occur from the numbers mentioned.

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For more on the February season, my strategy during reporting season and analysts' conviction buys and sells, see Weekly Insights updates from the weeks past:

https://www.fnarena.com/index.php/2022/02/24/rudis-view-more-beats-than-misses/

https://www.fnarena.com/index.php/2022/02/17/rudis-view-2022-the-big-adjustment/

https://www.fnarena.com/index.php/2022/02/10/rudis-view-february-results-macro-traps-and-opportunities/

https://www.fnarena.com/index.php/2022/02/03/rudis-view-february-looks-tricky/

https://www.fnarena.com/index.php/2022/01/27/rudis-view-risks-to-consider/

My latest on All-Weather Stocks:

https://www.fnarena.com/index.php/2022/01/20/rudis-view-all-weather-stocks-some-answers/

All-Weather Model Portfolio

December-January update for the FNArena/Vested Equities All-Weather Model Portfolio:

https://www.fnarena.com/downloadfile.php?p=w&n=64A40B6B-B074-8A81-C16CDDCA1F16EC8C

(This story was written on Tuesday 1st March, 2022. It was published on the day in the form of an email to paying subscribers, and again on Thursday 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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