Rudi On Thursday

This story features COCHLEAR LIMITED, and other companies. For more info SHARE ANALYSIS: COH

(This story was originally published on Wednesday, 15 July 2009. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

The market is readying itself for corporate results season, both in Australia and overseas. Thus far, investors have had a taste only of a few results releases in the US and some pre-announcements in Australia, but already it should be clear the upcoming results season will be a memorable one. The Street is expecting no less than average earnings per share (EPS) declines of some 39% in the US.

In Australia, expectations are milder, predominantly because of Australian banks and resources. Nevertheless, earnings for shareholders should decline by more than 20% and if current expectations are anything to go by, FY10 should again see further declines, albeit in low single digits. Adding to the uniqueness of the upcoming reporting season is that it has been preceded by nine consecutive months of falling market expectations (if we include July). This is the longest losing streak for as long as anyone can remember (I didn’t want to say “in history”, because it sounds very pompous, but it is probably correct).

Although share prices will, in a first instance, still respond to what comes out of the boardrooms of corporate Australia (and elsewhere), the real importance of July-August-September 2009 will be to find out what changes will have to be made to future forecasts. After all, eight or nine consecutive months (the longest period in history – there you have it) sounds very impressive, but what really counts is whether after all those cuts and reductions, market projections have finally fallen too far, so that the next cycle of forecast upgrades can commence.

Market strategists at RBS Australia think the answer is negative and that companies in Australia will merely match expectations, but not likely beat them decisively. We will all find out between now and mid-September.

As I have stated previously, I believe the key denominator remains what will happen with projections for FY11. Within the context of the upcoming results season this means: how will this year’s results season affect forecasts for FY11?

Strategists at JP Morgan, for instance, pointed out recently that even though analyst expectations have been falling steadily over the last eight months, they did so predominantly for FY09 and FY10. Forecasts for FY11 have been left largely unchanged. Does this mean we should all expect the worst? JP Morgan seems to suggest (softly) there is a danger for the need of a sudden market adjustment, but colleagues at UBS do not share any such sentiments. If anything, argues UBS, market expectations for FY11 seem poised for upward corrections.

On current market consensus forecasts, declining EPS reports in FY09 and FY10 should be followed up with a double digit jump (more than 20%) in FY11. UBS, however, has pencilled in 29% EPS growth for FY11 – well-above consensus.

All of the above does mask that analyst expectations at present are probably as wide and as dispersed as they have ever been – an observation made also by the above mentioned strategists at JP Morgan. Having personally spent quite some time in updating and assessing market expectations for FY10 and FY11 over the past weeks I can report the current range of analyst expectations, even for Australia’s blue chip stocks, is without any doubt the widest I have seen in the many years I have been closely monitoring the share market.

One could then expect the upcoming results season will bring analyst forecasts and projections closer in line with each other.

The upcoming results season will also see a significant fall in dividend payouts – by the end of August some 25%, if not more, will have evaporated from last year’s comparable dividend payouts. That’s probably going to set a new record too.

Because the enormous reductions in earnings and dividends have been preceded by an even larger fall in share prices, there is some good news for investors behind all these figures: price earnings ratios in Australia are below the historical norm of 15 and the average dividend ratio for the Australian share market is a little less than 5%. The historical average is around 4%.

The message behind these figures should be clear: this is a time to invest in the market, not to have large amounts in cash and government bonds. Of course, given the still uncertain economic outlook investors may want to keep in mind that stock selection and timing remain as important as ever.

To keep overall spirits high: UBS strategists believe that if we assume profits and dividends will revert back to their historical trends, the share market at present is likely up to 25% undervalued.

UBS believes the S&P200 index could be at 4400 by year end, implying a gain of a little over 12% (any dividends not included). Coincidentally, that is also what Citi strategists in the US forecast for the S&P500.

Zooming in on the shorter term outlook, companies are going to surprise to the upside as well as to the downside – but which ones?

Healthcare analysts at JP Morgan deserve a special mention because they’d already picked Cochlear ((COH)) as a potential underperformer – before management had to issue a profit warning this week. Those same analysts believe CSL ((CSL)) and ResMed ((RMD)) have the most potential in the sector to surprise to the upside.

Resources analysts at UBS are curious whether Iluka Resources ((ILU)) will be able to live up to expectations, while noting any shortfall might impact on the company’s funding requirements. The mineral sands miner will be one to watch this season.

UBS also expects to see an okay result from BHP Billiton ((BHP)), but with a likely cautious outlook, while iron ore miner Mount Gibson ((MGX)) is seen as a likely candidate to surprise positively.

RBS Australia recently published several lists of companies likely to surprise (positive) and likely to disappoint (negative). The first group includes, on RBS’s assessment, Coca-Cola Amatil ((CCL)), Woolworths ((WOW)), WorleyParsons ((WOR)), Ansell ((ANN)), United Group ((UGL)), Newcrest Mining ((NCM)), AGL Energy ((AGK)), Platinum Asset Management ((PTM)), Healthscope ((HSP)), IRESS ((IRE)) and SP Ausnet ((SPN)).

Companies likely to disappoint include Aristocrat ((ALL)), Consolidated Media ((CMJ)), AXA Asia Pacific ((AXA)), Lend Lease ((LLC)), Boart Longyear ((BLY)), Brambles ((BXB)), Qantas Airways ((QAN)), BHP Billiton, Fortescue Metals ((FMG)), Iluka Resources, Ten Network ((TEN)), Beach Petroleum ((BPT)), Roc Oil ((ROC)) and Gunns ((GNS)).

Quantatative analysts at Macquarie recently compiled their own lists. Positive surprises, say these analysts, are more likely to come from Karoon Gas ((KAR)), Extract Resources ((EXT)), Wotif.com ((WTF)), JB Hi-Fi ((JBH)), IRESS, Kingsgate Consolidated ((KCN)), IOOF Holdings ((IFL)), Ramsay Health Care ((RHC)), Coca-Cola Amatil, Eastern Star Gas ((ESG)), Platinum Asset Management, Caltex Australia ((CTX)), InvoCare ((IVC)), Tatts Group ((TTS)) and the Australian Stock Exchange ((ASX)).

On the list of potential disappointers we find the likes of Molopo Australia ((MPO)), Aquarius Platinum ((AQP)), Iluka Resources (again!), Elders (ELD)), St Barbara ((SBM)), BlueScope Steel ((BSL)). Boart Longyear, Sunland Group ((SDG)), Arrow Energy ((AOE)), PaperlinX ((PPX)), Murchison Metals ((MMX)), Macmahon Holdings ((MAH)), OneSteel ((OST)), Australian Agriculture Co ((AAC)) and FKP Property Group ((FKP)).

In general, there will be dividend cuts, asset write-downs, and lower sales and profits. The Australian dollar is likely to feature prominently. But what will matter the most is what company managements have to say about the way forward, and the overall impact of it all on FY10 and FY11 market estimates.

With these thoughts I leave you all this week,

Till next week!

Your editor,

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

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