Rudi On Thursday

This story features BORAL LIMITED, and other companies. For more info SHARE ANALYSIS: BLD

(This story was originally published on Wednesday January 28, 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).

Investors in Australia have already seen the first company results trickle through, in combination with preliminary profit warnings such as from Westfield ((WDC)) and Boral ((BLD)). The next few days will gradually see the pace pick up. Unfortunately, this applies to both the February interim results season gathering momentum with more and more companies releasing their financial results, as well as to profit warnings with more and more companies likely to be forced to warn investors that targets have not been achieved and expectations for what lies ahead may be too high.

Give it another two weeks and we’ll be right in the middle of it.

This year, of course, the local interim results season takes place against a background of continuously worsening economic indicators. This is why economists and investment strategists are constantly shifting their global growth projections further down, and why investors are more nervous than usual in the opening weeks of the new calendar year.

Expectations by securities analysts have consistently been too high since the second half of calendar 2007 (if not longer) -that is now widely regarded a fait accompli- but we don’t know yet what the exact gap is between forecasts and reality. How much further do earnings and dividend forecasts have to fall? All should be revealed in the five weeks ahead of us.

The good thing, as pointed out by strategists at UBS last week, is that current share prices already discount a very miserable outlook for corporate earnings. UBS strategists took this as a positive as it implies the share market has the ability to rise even as securities analysts will be adjusting their forecasts further downwards.

Even though most companies will be reporting half-yearly results, the February results season might prove to be a trade-off between what is likely to happen in fiscal 2009 (until June 30) and what seems probable for the financial year after that. For FY09, present market expectations are for more or less no earnings growth, on balance, across the Australian share market. While this seems like a dark scenario already, many experts will tell you this is likely to turn out too optimistic. The above mentioned strategists at UBS, for example, believe negative earnings growth in the order of 10-15% seems more feasible.

I have a suspicion it will be at least equally important what will happen to FY10 forecasts. Thus if overall confidence in FY10 profit and dividend projections remains as low as it has been over the year past, investors might have to wait until the August reporting season before getting a better grip on what is happening inside corporate Australia, and possibly even on the outlook for the Australian share market.

Returning to the upcoming results season, strategists and quant specialists at major stockbrokerages traditionally try to work out in advance which companies are likely to surprise or disappoint with their earnings release or future guidance. This annual exercise is always full of hits and misses, but it does give investors some clues about where the experts see the main risks and opportunities.

Put very simple: those companies who manage to genuinely surprise the market should see their share price respond positively, and those that disappoint risk getting slaughtered. Past analysis has shown the difference in share price performance between these two groups usually lasts up to three months. But then again, these are not normal times.

Strategists at ABN Amro believe potential upside surprises are likely to be found in the healthcare sector. The stockbroker has nominated CSL ((CSL)) and Sonic Healthcare ((SHL)) as its prime candidates. If correct, this would fall in line with what has been happening in the US recently where many of the positive earnings surprises came from companies in the healthcare industry, as well as from technology companies (unfortunately, Australia doesn’t have any peers for the likes of Apple or IBM).

In what is a recurring theme throughout broker previews to the upcoming results season, these two candidates for a positive surprise are vastly outnumbered by ABN Amro nominating 13 candidates that appear poised to disappoint. These 13 are: Alumina Ltd ((AWC)), AXA-Asia Pacific ((AXA)), BHP Billiton ((BHP)), BlueScope Steel ((BSL)), Commonwealth Bank ((CBA)), Harvey Norman ((HVN)), Insurance Australia Group ((IAG)), Lihir Gold ((LGL)), OneSteel ((OST)), PaperlinX ((PPX)), Perpetual ((PPT)), Rio Tinto ((RIO)) and Ten Network Holdings ((TEN)).

Again, ABN Amro has set a few recurring themes: resources, financials, retailers and media companies are most likely to deliver most of the negative surprises in February.

Strategists at Citi have taken a different approach. They looked for which stocks Citi forecasts were above the rest of the market, and for which stocks they are below the rest of the market. This could indicate, if Citi’s forecasts are more correct than the others, where some of the upcoming surprises and disappointments might come from.

Citi’s forecasts are above the market for Downer EDI ((DOW)), Foster’s ((FGL)), OneSteel, PaperlinX, Primary Healthcare ((PRY)), Ramsay Healthcare ((RHC)), STW Communications ((SGN)), Sonic Healthcare ((SHL)), Sigma Pharmaceuticals ((SIG)), Santos ((STO)) and WHK Group ((WHG)).

The opposite group contains many more stocks and includes many media companies, retailers, financials and engineers/service providers to the commodities sector.

Citi’s approach looks like a double edged sword as it can be read in both ways: if these forecasts prove correct, Citi analysts were simply ahead of the market, if wrong it signals where the surprises and disappointments will come from.

At Macquarie, the team of quant analysts have taken a similar approach as ABN Amro. Macquarie’s nominations for a probable positive surprise are: Origin Energy ((ORG)), Iluka Resources ((ILU)), Ansell ((ANN)), Amcor ((AMC)), Coca-Cola Amatil ((CCL)), Telstra ((TLS)), Energy Resources Of Australia ((ERA)), Insurance Australia Group, Cochlear ((COH)), CSL, Ramsay Health Care, AGL Energy ((AGK)), Lion Nathan ((LNN)), Coal & Allied ((CNA)) and Woolworths ((WOW)).

As such, the team at Macquarie continues on the theme of healthcare (plus various other defensive stocks) in combination with mostly energy-related stocks.

Companies likely to disappoint, according to Macquarie, include Bluescope Steel, Arrow Energy ((AOE)), Caltex Australia ((CTX)), Fortescue Metals Group ((FMG)), Macquarie Airports ((MAP)), Rio Tinto, Alumina Limited, Axa Asia-Pacific, Onesteel, BHP Billiton, Paladin Energy ((PDN)), Santos, Lihir Gold and Commonwealth Bank Of Australia ((CBA)).

Macquarie also nominated Sims Metal ((SGM)) but management already came out with a profit warning this week, proving their nomination had been correct.

Over at GSJB Were, market strategists believe Australian Infrastructure ((AIX)), ANZ Bank ((ANZ)), Austbrokers ((AUB)), Graincorp ((GNC)), Iress ((IRE)), Nufarm ((NUF)), Toll Holdings ((TOL)), Westpac ((WBC)) and Woodside ((WPL)) are most likely to surprise. (Note: ANZ Bank and Westpac report later).

Downside earnings risk is believed the highest at Australian Agricultural Co ((AAC)), Western Areas ((WSA)), Apex Minerals ((AXM)), B&B Infra ((BBI)), Mount Gibson ((MGX)), Timbercorp ((TIM)), PanAust ((PNA)), Aditya Birla ((ABY)), Minara Resources ((MRE)), Australian Vintage ((AVG)), ConnectEast ((CEU)), Independence Group ((IGO)), Platinum Australia ((PLA)), Ten Network, Incitec Pivot ((IPL)), Norfolk Group ((NFK)), FKP Property ((FKP)), Seven and Harvey Norman.

JP Morgan analysts have applied the theme to their small cap universe and come up with the following candidates likely to surprise: AJ Lucas Group ((AJL)), Credit Corp ((CCP)), Domino’s Pizza Enterprises ((DMP)), the MAC Services Group ((MSL)) and Tox Free Solutions ((TOX)).

Negative surprises are most likely to come from Crane Group ((CRG)), Spotless ((SPT)) and WDS ((WDS)), says JP Morgan.

The accuracy of all these predictions will be put to the test in the five weeks ahead.

Special Note: the FNArena calendar is being updated regularly and will continue to be updated regularly throughout the month of February.

With these thoughts I leave you all,

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team of Greg, Chris, Grahame, George, Joyce, Pat and Andrew)

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